Whenever the Union Budget of India is presented, the term FRBM is seen in the news. You may see headlines like ‘FRBM targets are missed’ or ‘FRBM targets are met’. What exactly is FRBM? What is the significance of FRBM for Indian economy?
Fiscal Responsibility and Budget Management (FRBM) Bill was introduced in the parliament of India in the year 2000 by Atal Bihari Vajpayee Government for providing legal backing to the fiscal discipline to be institutionalised in the country. Subsequently, the FRBM Act was passed in the year 2003. It is an act of the parliament that set targets for the Government of India to establish financial discipline, improve the management of public funds, strengthen fiscal prudence and reduce its fiscal deficits.
Why was the FRBM Act enacted?
In India, the borrowing levels were very high in the 1990s and 2000s. Indian Economy was weak as it had a high Fiscal Deficit, high Revenue Deficit, and high Debt-to-GDP ratio.
By 2003, the continuous government borrowing and the resultant debt had severely impacted the health of the Indian economy. Much of the borrowing was utilized for interest payments of previous borrowings, but not for productive-purposes. This resulted in interest payments becoming the largest expenditure item of the government.
Many economists then warned the government that this condition is not sustainable. They advised legal steps to prevent India from falling into a debt-trap.
Parliamentarians of India too felt that there should be control over the government of India not to resort to a high level of borrowing to fund its expenditure. Hence in 2000, they introduced a bill to bring responsibility and discipline in matters of expenditure and debt. This bill was passed by the Indian Parliament in 2003 and came to be known as the Fiscal Responsibility and Budget Management Act.
Key features of the FRBM Act
The FRBM Act proposed that revenue deficit, fiscal deficit, tax revenue, and the total outstanding liabilities be projected as a percentage of gross domestic product (GDP) in the medium-term fiscal policy statement.
The FRBM act also provided for certain documents to be tabled in the Parliament of India, along with Budget, annually with regards to the country’s fiscal policy. This included the Medium-term Fiscal Policy Statement, Fiscal Policy Strategy Statement, Macro-economic Framework Statement, and Medium-term Expenditure Framework Statement.
How effective has the FRBM Act been?
Several years have passed since the FRBM Act was enacted, but the Government of India has not been able to achieve targets set under it. The Act has been amended several times.
In 2013, the government introduced a change and introduced the concept of Effective Revenue Deficit (E.R.D). This implies that effective revenue deficit would be equal to revenue deficit minus grants to states for the creation of capital assets. In 2016, a committee under N K Singh was set up to suggest changes to the Act. According to the government, the targets set under the FRBM Act previously were too rigid.
FRBM Review Committee headed by NK Singh: Recommendations
In May 2016, the government set up a committee under NK Singh to review the FRBM Act. The task was to review the performance of the FRBM Act and suggest the necessary changes to the provisions of the act. The committee recommended that the government should target a fiscal deficit of 3 percent of the GDP in years up to March 31, 2020, cut it to 2.8 percent in 2020-21 and to 2.5 percent by 2023. The Committee suggested using debt as the primary target for fiscal policy.
These were the targets set by NK Singh:
- Debt to GDP ratio: The review committee advocated for a Debt to GDP ratio of 60% to be targeted with a 40% limit for the centre and 20% limit for the states.
- Revenue Deficit Target – Revenue deficit should be reduced to 0.8% of GDP by March 31, 2023. The minimum annual reduction target was 0.5% of GDP.
- Fiscal Deficit Target – fiscal deficit should be reduced to 2.5% of GDP by March 31, 2023. The minimum annual reduction target was 0.3% of GDP.
Latest FRBM Targets
The latest provisions of the FRBM act requires the government to limit the fiscal deficit to 3% of the GDP by March 31, 2021, and the debt of the central government to 40% of the GDP by 2024-25, among others.
The Act provides room for deviation from the annual fiscal deficit target under certain conditions.
Escape Clause in the FRBM Act
The Finance Minister invoked the ‘escape clause’ by saying she was taking a deviation of 0.5 percentage points from the fiscal deficit targets set out earlier. She pegged the revised estimates of fiscal deficit as a percentage of the GDP for FY20 and FY21 at 3.8 percent and 3.5 percent, respectively. What does it mean?
The escape clause under the FRBM Act details a set of events in which the Central government can deviate from fiscal deficit targets.
In 2017, the FRBM Review Committee headed by NK Singh said that the exceptional circumstances cited in the FRBM Act, 2003 were defined opaquely and were liable to misuse. In 2018, the FRBM Act was amended to specify three conditions upon which the escape clause can be invoked. First, overriding considerations of national security, acts of war, and calamities of national proportion and collapse of agriculture severely affecting farm output and incomes. Second, far-reaching structural reforms in the economy with unanticipated fiscal implications. Three, a sharp decline in real output growth of at least 3 percentage points below the average for the previous four quarters. The FRBM amendments also mentioned that the deviation from the stipulated fiscal deficit target must not exceed 0.5 percentage points in a year.
In the recent Budget, the government seems to have invoked the second condition. The quantum of deviation taken was the upper end of the limit — 0.5 percentage points.
Do note that the term ‘escape clause’ is not used in the FRBM Act, but only in the FRBM Review Committee report.
Why is it important?
For any country, the costs of not adhering to fiscal deficit targets can be substantial. The review report on FRBM pointed out that the years after the global financial crisis, when India did not adhere to the envisaged path of fiscal consolidation, were associated with macroeconomic instability, pushing the economy to the brink during the ‘taper tantrum’ crisis of 2013. But when economic activity is going through a lean patch and there isn’t enough demand, it may become necessary to use fiscal policy to engineer a revival.
The FRBM review committee was constituted to understand fiscal issues and lay down a framework on deviations. Some of the provisions related to the escape clause in the FRBM Act today are in line with the Committee’s recommendations.
Invoking the escape clause has its pros and cons. On the plus side, it creates extra elbow room for the Centre to boost a slowing economy by clearing its dues to businesses, paying more to staff or awarding new projects. On the other hand, the resulting higher borrowings can mean more debt and a higher interest outgo, which can cost taxpayers dearly in the long run.
The FRBM Act seeks to achieve long-term macroeconomic stability, while generating budget surpluses, prudential debt management, limiting borrowings to cut down deficits and debt, greater transparency, removal of fiscal impediments and providing a medium-term framework for budgetary implementation.
As observed, different governments have failed to achieve the FRBM targets set to be achieved in 2008 even by 2020.
Though the Act aims to achieve deficit reductions prima facie, an important objective is to achieve inter-generational equity in fiscal management. This is because when there are high borrowings today, it should be repaid by the future generation. But the benefit from high expenditure and debt today goes to the present generation.
Achieving FRBM targets thus ensures intergenerational equity by reducing the debt burden of the future generation.