Analysis of Fiscal Responsibility and Budget Management (FRBM) Act

Syllabus: Indian Economy – Fiscal Consolidation in India

Source: BS

Context: The Fiscal Responsibility and Budget Management (FRBM) Act of 2003 set a target to reduce the gross fiscal deficit (GFD) to 3% of GDP by 2008. By April 2018, this was replaced with a debt-GDP ratio of 40%, with the GFD of 3% as an operational target.

What is FRBM?

The Fiscal Responsibility and Budget Management (FRBM) Act of 2003 is an Indian law aimed at improving the government’s fiscal management. It sets targets for reducing the gross fiscal deficit (GFD) and the government’s debt-to-GDP ratio, ensuring fiscal discipline, and enhancing transparency in budgeting.

The main objectives of the FRBM Act include:

Objective | Description

Fiscal Discipline | Instils discipline in managing public finances, aiming to progressively reduce revenue and fiscal deficits to sustainable levels.

Debt Management | Keeps public debt within reasonable limits, enhancing transparency and accountability through specific fiscal targets and regular reporting.

Long-Term Sustainability | Ensures long-term fiscal sustainability by controlling deficits and managing debt.

Resource Allocation | Optimizes resource allocation by reducing wasteful expenditures and prioritizing essential sectors like education and infrastructure.

Macroeconomic Stability | Brings macroeconomic stability by controlling inflation, maintaining the exchange rate, and avoiding economic imbalances.

How was India’s journey towards fiscal consolidation?

Period | Reduction in GFD | Pace and Method

First Period (2003-2008) | GFD reduced from 5.8% in 2002-03 to 2.6% in 2007-08. However, GFD surged to 6.6% by 2009-10 due to the global financial crisis. | Rapid consolidation averaging 0.6% of GDP annually; achieved by compressing expenditure (2.1%) and augmenting revenue (1.1%). Gross tax-GDP ratio increased from 9.1% to 12.1%.

Second Period (2010-2019) | GFD reduced to 3.4% of GDP by 2018-19. However, the Pandemic pushed GFD to 9.2% of GDP in 2020-21 and the debt-GDP ratio to 61%. | Slowed consolidation averaging 0.2% of GDP annually; achieved by expenditure compression (1.5 %) and revenue augmentation (0.2 %). Tax-GDP ratio remained at 10.5%.

FRBM has been successful in achieving fiscal consolidation because:

• The FRBM Act initially succeeded in reducing the fiscal deficit from 5.8 % of GDP in 2002-03 to 2.6% in 2007-08. The revenue deficit also saw a decline during this period.

• Fiscal policies on target like FY25, the government estimates the fiscal deficit at 5.1 per cent of the GDP which spiked up due to COVID.

• Strong accountability due to the mandatory medium-term and strategy statements which are required to be presented annually before Parliament.

However, FRBM is ineffective on various fronts like:

• Reduced expenditure: While there is a fall in deficits, it has largely been on account of reductions in expenditure in critical sectors such as education, health etc. Eg: Finance ministry report, State’s capex declined by over 7% so far in 2023-24.

• Eg: Finance ministry report, State’s capex declined by over 7% so far in 2023-24.

• Budgetary innovations: achieved the deficit targets by manipulating the revenue and expenditure accounts such as curtailing the capital expenditure. Eg: The introduction of an Effective primary deficit indicator has led to the decline of deficit.

• Eg: The introduction of an Effective primary deficit indicator has led to the decline of deficit.

• High Debt to GDP: The government has time and again used escape clauses in FRBM to reset the new targets and miss deadlines. Eg: According to FinMin India Debt to GDP is 81% in FY2022 (significantly above the FRBM Act’s target of 40% for the Centre, 20% for States, and 60% for combined accounts)

• Eg: According to FinMin India Debt to GDP is 81% in FY2022 (significantly above the FRBM Act’s target of 40% for the Centre, 20% for States, and 60% for combined accounts)

• Divergent state policies: Even though the states have an FRBM limit of 3.5% of State GDP due to populist policy many states are facing revenue deficits. Eg: the 15th FC report shows that 12 states face a revenue deficit even after the central grant.

• Eg: the 15th FC report shows that 12 states face a revenue deficit even after the central grant.

• Hiking macroeconomic indicators: India has a vulnerability in stable prices, CAD and unemployment leading to a lack of fiscal prudence.

India’s fiscal consolidation journey highlights key lessons:

• Impact of Shocks: Exogenous shocks can disrupt consolidation, stressing the need for ample fiscal space in stable conditions.

• Tax-GDP Ratio: Improving the tax-GDP ratio is crucial for sustainable consolidation; relying solely on expenditure cuts is insufficient.

• Rationalizing Expenditure: Efficient expenditure management is necessary to handle future shocks.

Conclusion:

The government should focus on revamping of FRBM Act along the lines of NK Singh’s committee recommendation such as adaptation of the glide path to achieve the target, establishing of independent fiscal council, conscience use of escape clause and coordinating monetary and fiscal policy to achieve the Fiscal consolidation and prudence.

Mains Link:

Public expenditure management is a challenge to the Government of India in the context of budget-making during the post-liberalization period. Clarify it. (UPSC 2019)

Prelims Links:

Consider the following statements: (UPSC 2018)

• The Fiscal Responsibility and Budget Management (FRBM) Review Committee Report has recommended a debt to GDP ratio of 60% for the general (combined) government by 2023, comprising 40% for the Central Government and 20% for the State Governments.

• The Central Government has domestic liabilities of 21% of GDP as compared to that of 49% of GDP of the State Governments.

• As per the Constitution of India, it is mandatory for a State to take the Central Government’s consent for raising any loan if the former owes any outstanding liabilities to the latter.

Which of the statements given above is/are correct?

(a) 1 only (b) 2 and 3 only (c) 1 and 3 only (d) 1, 2 and 3

Ans: C