Daily Editorials – India’s Fiscal Policy

• India’s Fiscal Policy

1. What is fiscal policy

2. History

3. FRBM Act

4. Challenges with implementation

5. N.K.Singh Committee

6. Way Ahead

Click here to Download Daily Editorial (21 November 2016)

Context-  Finance Minister constituted a committee to review the FRBM Act in the light of current domestic and global dynamics. The committee is expected to submit its report by the end of the this month .

What is fiscal policy

Fiscal Policy is the means by which a government adjusts its spending level and tax rates to monitor and influence its economy.

Fiscal policy is based on the theories of British economist John Maynard Keynes. The theory in Keynesian economics states that governments can influence macroeconomic productivity levels by increasing or decreasing tax levels and public spending .

There are two broad types of fiscal policy

1.Expansionary policy – When economy is in recession , this type of policy is employed which results in an increase in the government spending or lowering of taxes.

2.Contractionary policy – When an economy is in a state where growth is at a rate that is getting out of control (causing inflation and asset bubbles), contractionary fiscal policy can be used to stabilize it at more sustainable level.

History

During the first 45 years after independence, India’s economy was divided into two distinct segments, private and public. Government had a major role in the economy while private sector indulged mostly in small and medium enterprises.

The taxation was heavy on wealthy people, custom tariffs going as high as 400% .

By 1997-98, fiscal reforms brought peak personal tax rates down to 30 per cent and corporate rates to a moderate 35 per cent.

FRBM Act

FRBM Act was first introduced in India in December 2000 and enacted in 2003, to stabilize the increasing government deficits both at the Centre and in the States.

The FRBM Act brought as rising government borrowing and the resultant government debts had seriously eroded the financial health of the government . With inadequate revenues, government resorted to high level of borrowing which resulted into high interest payments. In this way, interest payments became the largest expenditure item of the government.

The FRBM Act institutionalised fiscal discipline, by seeking to eliminate revenue deficit and to bring down fiscal deficit to a manageable 3% of GDP by FY08 .

The key provisions of the Act and the FRBM rules are:

• Every year the government will bring down revenue deficit by 0.5% and eliminate it by 2007-08.
• Every year, the government will bring down fiscal deficit by 0.3% and bring it down to 3% by 2007-08.
• Total liabilities of the Union Government should not rise by more than 9% a year.
• Union Government would not give guarantee to loans raised by PSUs and State governments for more than 0.5% of the GDP in aggregate.
• Union Government would place three more documents along with the budget documents viz. Macroeconomic Framework Statement, Medium Term Fiscal Policy Statement and the Fiscal Policy Strategy Statement.
• At the end of second quarter, the Finance Minister would make a statement on the trend of fiscal indicators and corrective measures taken

But due to the global  financial crisis of 2008 and hence sharp decline in private investment,  government spending became critical to revive growth and the deadline for attainment of the target was pushed forward and later suspended. In last few years the act has been largely neglected.

Challenges in implementation 

• Populist giveaways, in the form of farm loan waivers, large pay revisions to government employees .
• A fix point fiscal target , though infuses fiscal discipline but  limits the room for government and provides an unambiguous signal to the bond markets
• No autonomous body to review the working of FRBM act.
• it might require the government to cut back on social expenditure necessary to create productive assets and general upliftment of poor.
• Government deviated from the path of fiscal correction in the wake of the global financial crisis and unanticipated changes in the prices of oil and fertilizers in 2008-09.
• Creative Accounting – In 2010-11, Government came up with the concept of Effective Revenue Deficit in the budget documents.
• In Budget 2012-13, the finance act changed the FRBM act and dumped the centre’s commitment to eliminate the revenue deficit. Instead, it brought in a new commitment of eliminating the effective revenue deficit .
• The amended rules extended the time for elimination of Effective revenue deficit by March 2015 and bringing down fiscal deficit to 3% by March 2017.
• Uncertain and volatile global economy and hence its effects on Indian fiscal consolidation.

N.K.Singh Panel to review FRBM Act 

This year, in budget 2016 it was proposed to constitute a Committee to review the implementation of the FRBM Act. The mandate of the panel was to –

• To Review the working of the FRBM Act over last 12 years and to suggest the way forward- keeping in view the objectives of fiscal consolidation and the changes required in the context of uncertain and volatile  global economy
• To consider the possibility of replacing absolute fiscal deficit targets with a target range that may be adjusted in line with the overall credit trends in the economy.
• To examine the need and feasibility of aligning the fiscal expansion or contraction with credit contraction or expansion in the economy.

Way Ahead

• Both the 13th and 14th FC recommended the establishment of Fiscal Accountability Council to review fiscal performance under FRBM Act. The council will help in better understanding the fiscal trajectory and will contribute to a more informed public debate.
• Brining a fiscal range instead of point target will provide the needed flexibility to the government .
• A policy with spending rule along with a medium-term debt range that takes into account the specific institutional setting in each country would help to enhance the policy credibility and facilitate effective monitoring that would ensure stability, fairness and efficiency.
• Improve budgetary process. Avoiding populism in terms of heavy expenditure in schemes , poor implementation , lack of accounting .
• Increase export of value added products raTher than just raw materials.
• Curbing out flow of unaccounted money , bringing better tax laws which makes evasion and avoidance difficult.
• Government bailouts should not be a norm , bringing people with huge NPA in banks accountable to law.