The analysis of FRBM Act in India

Source: This post ‘The analysis of FRBM Act in India’ is created based on the article A call for greater focus on revenue side, published in Business Standard on 19^th July 2024.

UPSC Syllabus: GS Paper 3 – Indian Economy – Fiscal Consolidation in India

Context: The article highlights India’s journey of Fiscal Responsibility and Budget Management (FRBM) Act and the lessons that India can take from this journey.

The Fiscal Responsibility and Budget Management (FRBM) Act, enacted in August 2003. It aimed to bring fiscal discipline by mandating the central government to reduce the Gross Fiscal Deficit (GFD) to 3% of GDP by 2008.

This target was revised in April 2018 to focus on a debt-GDP ratio of 40%, with the GFD of 3% remaining the operational target.

How was India’s journey towards fiscal consolidation?

First Period (2003-2008):

• Reduction in GFD: GFD reduced from 5.8% in 2002-03 to 2.6% in 2007-08.
• Impact of Global Financial Crisis: The GFD surged to 6.6% by 2009-10 due to the global financial crisis following the collapse of Lehman Brothers.
• Pace and Method: Fiscal consolidation was rapid, averaging 0.6% of GDP annually. This was achieved by compressing expenditure (2.1 percentage points) and augmenting revenue (1.1 percentage points). The gross tax-GDP ratio increased from 9.1% in 2003-04 to 12.1% by 2007-08.

Second Period (2010-2019):

• Reduction in GFD: GFD was reduced to 3.4% of GDP by 2018-19.
• Pandemic Impact: The pandemic in 2020 pushed the GFD to 9.2% of GDP in 2020-21, and the debt-GDP ratio to 61.0%, far exceeding the target.
• Pace and Method: Fiscal consolidation slowed to an average of 0.2% of GDP annually, with expenditure compression accounting for 1.5 percentage points and revenue augmentation for 0.2 percentage points. The tax-GDP ratio remained broadly unchanged at 10.5% during this period.

What are major lessons learned by India in the process of fiscal consolidation?

Impact of Exogenous Shocks: Major exogenous shocks can derail fiscal consolidation efforts, highlighting the need for creating sufficient fiscal space during normal macroeconomic conditions.

Tax-GDP Ratio: Sustainable fiscal consolidation requires improving the tax-GDP ratio. There are limits to achieving fiscal consolidation through expenditure compression alone.

Rationalizing Expenditure: Wherever possible, expenditure needs to be rationalized to create fiscal space for future exogenous shocks.

Future Fiscal Path: The central government has reduced the GFD to 5.8% of GDP in 2023-24 and aims to bring it down to 5.1% in 2024-25. Despite this, the debt-GDP ratio remains elevated at 55.3% in 2023-24.

Long-term Projections: Given the current macroeconomic conditions, with a primary deficit reduction of 0.6% of GDP annually from 2025-26 to 2030, the debt-GDP ratio is projected to moderate to 54.4% by 2030.