The pandemic-flagged need for a new fiscal framework

Source: The post is based on an article “The pandemic-flagged need for a new fiscal framework” published in the Live Mint on 12^th July 2022.

Syllabus: GS3 – Union Budgeting

Relevance: Fiscal Framework

News: In recent years, there has been suspension of fiscal rules across the globe due to the global financial crisis (GFC).

What were the causes behind suspension of the fiscal rules?

The costs of dealing with the pandemic has raised global government and private debt to record-high levels.

The GFC crisis has been compounded by the Russia-Ukraine conflict in the year 2022.

What are the traditional government approaches in the fiscal management domain?

Fiscal architecture: It involves a fiscal strategy, supported by fiscal institutions such as an accountable and efficient public financial management system (PFM).

Fiscal rules: There has been advocacy for well-designed and implemented numerical fiscal rules. These rules help strengthen the credibility of an administration’s commitment to fiscal sustainability.

What were the issues in the numerical fiscal rules approach?

India adopted numerical fiscal rules in 2003. However, there was pre-covid evidence that demonstrated that numerical fiscal rules did not prevent a large debt build-up over time. Therefore, the rigid numerical fiscal rules did more harm than good.

Thus, it prompted modification of existing rules and revamping of escape clauses. Therefore, the Centre updated the Fiscal Responsibility and Budget Management (FRBM) Act in 2018 and adopted multiple fiscal indicators as targets.

What are the issues with India’s new fiscal rule regime?

The fiscal rules have been effectively circumvented by off-budget fiscal operations, inconsistent budget classification and accounting standards. In addition, there have been improper use of public accounts for budgetary purposes in India.

Definitions of key targets, such as ‘fiscal deficit’ or ‘public debt’, vary across state governments and the Centre.

Though the PFM system was strengthened. But it has been able to meet only a fraction of best practice standards. It cannot check misclassification of accounts for compliance.

Way forward

India needs to develop a system which mandates fiscal sustainability through institutional framework. The institutions should also be allowed to take judgement in the times of crisis.

For example, fiscal responsibility principles should not be time-bound, but must allow the government to manage shocks. This can be done through three key steps:

(1) Instead of adopting numerical fiscal rules, the government should adopt the principles of fiscal responsibility. Such a model has been adopted by New Zealand, Australia and the UK.

(2) Various stands, criteria, procedures and methods should be established. This should be devised in a manner that ensures that standards are being met.

(3) There must be institutions to do surveillance and to determine ex-post compliance with the fiscal responsibility principle.

In a post-pandemic framework, overall, India needs to improve the quality and efficiency of public spending and financial management across all levels of government.

(A) The New Zealand Model –Principles-Based Fiscal Strategy

(1) NZ has enacted ‘the fiscal strategy act’, which requires adherence to the standards and principles of responsible fiscal management. For example, a medium-to-long-term fiscal sustainability report etc.

(2) The government publishes an annual fiscal strategy explaining how its annual fiscal plan is consistent with the standards set out in the law etc.

(3) It ensures transparent public reporting at regular frequency. Further, a periodic public review of the government’s fiscal plans is done by the Parliament and independent fiscal institutions.

(B) In doing this, India should move toward a new principles-based fiscal strategy, rather than returning to a fiscal framework based on rigid numerical fiscal targets.