FRBM Act – Provisions, Significance & Challenges – Explained Pointwise

Introduction:

• FRBM Act stands for Fiscal Responsibility and Budget Management Act enacted in 2003, aims to promote fiscal discipline, transparency, and accountability in the management of India’s finances.
• The Fiscal Responsibility and Budget Management Act, 2003 is regulated by the Department of Economic Affairs, Ministry of Finance.
• Fiscal Responsibility and Budget Management Act, 2003 ensure inter-generational equity in fiscal management and long-term macro-economic stability by reducing fiscal deficit. It was enacted for effective conduct of monetary policy and prudential debt management consistent with fiscal sustainability.
• FRBM Act mandates the following statements to be laid before the Parliament along with the Budget:
  • Macro-economic Framework Statement.
  • Medium Term Fiscal Policy Statement.
  • Fiscal Policy Strategy Statement.
• The Fiscal Responsibility and Budget Management Committee was constituted under the chairmanship of N.K.Singh to review the government’s fiscal performance and make recommendations to FRBM Act.

FRBM Act: Provisions:

The Central Government shall:

• Take appropriate measures to limit the fiscal deficit up to 3% of gross domestic product by the 31st March, 2021.
• Endeavor to ensure that:
  • The General Government (Centre + State) debt does not exceed 60%.
  • The Central Government debt does not exceed 40% of gross domestic product by the  end of financial year 2024-2025.
• Not give additional guarantees with respect to any loan on security of the Consolidated Fund of India in excess of one-half per cent of gross domestic product, in any financial year.
• Endeavour to ensure that the fiscal targets specified in clauses (a) and (b) are not exceeded after stipulated target dates.

FRBM Act: Amendments:

Since the enactment of the FRBM act in 2003, it has been amended 4 times – 2004, 2012, 2015 & 2018. The FRBM Act and the Rules underwent more significant changes during the 4th Amendment, in 2018.

N.K. Singh Committee Recommendations:

1. Debt to GDP ratio: The Committee suggested using debt as the primary target for fiscal policy. A debt to GDP ratio of 60% should be targeted with a 40% limit for the centre and 20% limit for the states.
2. To achieve the targeted debt to GDP ratio, it proposed yearly targets to progressively reduce the fiscal and revenue deficits till 2023.
3. The Committee proposed to create an autonomous Fiscal Council with a Chairperson and two members appointed by the centre.
4. The Committee noted that under the FRBM Act, the government can deviate from the targets in case of a national calamity, national security or other exceptional circumstances notified by it.
5. Escape Clause: The government may be allowed to deviate from the specified targets upon the advice of the Fiscal Council in the following circumstances:
   1. Considerations of national security, war, national calamities and collapse of agriculture affecting output and incomes.
   2. Structural reforms in the economy resulting in fiscal implications.
   3. Decline in real output growth of at least 3% below the average of the previous four quarters. These deviations cannot be more than 0.5% of GDP in a year.
6. The Committee recommended that the 15th Finance Commission (which was also led by N.K.Singh) should be asked to recommend the debt trajectory for individual states.

Significance of FRBM Act:

1. Fiscal discipline: The FRBM Act promotes fiscal discipline by setting up the targets for reducing the fiscal deficit and by mandating the constitution of a Fiscal Responsibility and Budget Management Committee (FRBMC) to review the government’s fiscal performance.
2. Fiscal transparency: The FRBM Act promotes transparency and accountability of public finances through publication of various reports, such as the annual budget, the medium-term fiscal policy statement, and the Fiscal Policy Strategy Statement.
3. Macroeconomic stability: The FRBM Act aims to maintain macroeconomic stability by ensuring that the government’s fiscal policies are sustainable and do not lead to high levels of public debt.
4. Investor confidence: The FRBM Act helps to boost investor confidence in the Indian economy by transparency and compliance and demonstrating the government’s commitment to fiscal discipline and macroeconomic stability.
5. Long-term planning: The FRBM Act requires the government to present a medium-term fiscal policy statement and an FPSS, which helps in long-term planning and ensures that the government’s fiscal policies are aligned with its future economic goals.
6. Inter-Generational Equity: FRBM Act emphasizes the responsibility of the government to maintain fiscal prudence so that future generations are not burdened by excessive debt.

Issues with FRBM Act:

1. Frequent Deviations and Use of Escape Clause:
   1. The government often fails to meet deficit and debt targets, invoking broad escape clauses in times of economic stress, natural disasters, or revenue shortfalls, undermining the Act’s credibility.
   2. During major events (e.g., pandemic, GST introduction), targets have been postponed and reset several times.
2. Rigid Fiscal Targets v/s Growth Needs: Fixed deficit targets (like 3% of GDP) can be too inflexible during downturns, limiting the government’s ability to stimulate the economy with increased spending when needed.
3. Weak Enforcement & Accountability:
   1. No strong penalties or incentives for non-compliance; governments face limited consequences for missing targets.
   2. Parliamentary and independent oversight are not always rigorous, allowing deviations to go unchecked.
4. Transparency & Classification Issues:
   1. Governments sometimes manipulate fiscal data by shifting expenditures off-budget, creative accounting, or reducing spending on critical social services to achieve targets.
   2. Lack of clarity in what qualifies as “revenue expenditure” or “capital expenditure” can obscure true fiscal positions.
5. Impact on States and Fiscal Federalism:
   1. Centralized fiscal authority has led to tension with states, who argue that FRBM impinges on their fiscal autonomy and lacks sensitivity to their varying needs.
   2. States are pressured to adhere to union-dictated deficit targets, even when their economic situations differ.

Way Forward:

1. Introduce a Credible Debt Anchor: Shift focus from rigid fiscal deficit targets to a debt-to-GDP ratio anchor (such as the 60% general government debt recommended by the N.K. Singh Committee), aligning with best international practices and ensuring inter-generational equity.
2. Strengthen Escape Clauses & Trigger Mechanisms: Clearly define and limit the use of escape clauses only for major shocks (pandemics, disasters, financial crises), with transparent triggers and conditions to prevent frequent fiscal slippage or misuse.
3. Revise Fiscal Deficit Target Periodically:
   1. Make fiscal targets more flexible, revising them in response to macroeconomic changes, business cycles, and structural reforms while protecting spending on key priorities.
   2. Allow phased fiscal consolidation to minimize adverse effects on the social sector and capital investment.
4. Improve Centre-State Coordination: Evolve joint targets and monitoring frameworks for deficit and debt, tailored to state-specific needs, reducing centre-state tensions and fostering cooperative federalism.
5. Enhance Transparency & Accountability: Ensure full disclosure of off-budget borrowings, guarantees, and contingent liabilities to avoid creative accounting and hidden fiscal risks.
6. Establish Fiscal Council: Set up an independent Fiscal Council to assess compliance, review projections, and advise on fiscal policy, increasing credibility and transparency.
7. Prioritise the Quality of Expenditure: The FRBM Act has traditionally focused on controlling the quantity of government spending, but the quality of that spending is just as important. The Act should distinguish between revenue expenditure (like salaries and subsidies) and capital expenditure (like building roads, ports, and power plants).

Conclusion:
FRBM Act is central to India’s fiscal discipline and macroeconomic stability. However, it should shift from a rigid rule-based system into a dynamic and credible tool that ensures both fiscal discipline and sustainable economic growth.