FRBM ACT: A Financial Discipline Target

The Fiscal Responsibility and Budget Management Act 2003 establishes a goal for the government to achieve financial independence, enhance public-fund management, and minimise the fiscal deficit.

The Act, passed in 2003, establishes a target for the government to reduce the budget deficit.

What is FRBM Act?

In December 2000, the then-Finance Minister of India, Mr Yashwant Sinha, introduced The Fiscal Responsibility and Budget Management Bill (FRBM Bill)in India. The FRBM act intends to increase standardised transparency in India’s fiscal management system.

The FRBM Act is concerned with the maintenance of a balance between government revenue and government spending.

By March 31, 2021, the Act mandates that the fiscal deficit be limited to 3% of the country’s gross domestic product (GDP). Meanwhile, the government’s debt should get limited to 40% of GDP by 2024-25.

The FRBM Act intended to bring –

• fiscal discipline
• efficient expenditure, revenue, and debt management
• Stability in the macroeconomic environment
• improved coordination of fiscal and monetary policy.
• Transparency in the government’s fiscal operations
• acquiring a balanced budget

OBJECTIVES OF THE FRBM ACT

The main objectives of the act include:

• to implement transparent fiscal management systems throughout the country
• to implement a more equitable and manageable debt distribution for the country over time
• to strive for long-term fiscal stability in India.

Furthermore, the expectation from the act was to provide the Reserve Bank of India (RBI) with the necessary flexibility for managing inflation in India.

FISCAL POLICY STRATEGY STATEMENT

Under Section 3(4) of the 2003 Fiscal Responsibility and Budget Management (FRBM) Act, the Fiscal Policy Strategy Statement gets delivered to Parliament.

It outlines the government’s fiscal priorities for the upcoming fiscal year, including taxation, expenditure, lending and investments, administered pricing, borrowings, and guarantees.

The statement shows how current policies align with solid fiscal management principles and justifies any substantial deviations in necessary fiscal measures made in recent years.

The Interim Budget made no mention of such a statement. In its Fiscal Policy Strategy Statement for Budget 2018, the government aimed to achieve the following goals:

• Targeting both the fiscal deficit and the debt at the same time
• Establishing a fiscal deficit target as an operational goal and ensuring that the government achieves a fiscal deficit of 3% of GDP by FY21
• The central government shall strive to maintain a declining debt trajectory and a debt target of 40% of GDP by FY25, with general government debt of 60%.
• It decide whether the FRBM Act’s goals may be eased or strengthened by incorporating sufficiently defined escape and buoyancy clauses.

HISTORY OF THE FRBM ACT

Borrowing levels in India were extraordinarily high in the 1990s and 2000s.

By 2003, the constant government borrowing and the resulting debt severely harmed the Indian economy.

As a result, the Indian parliament felt that the government of India should be held accountable for not relying on excessive levels of borrowing to support its expenses and that it was necessary to institutionalise some kind of fiscal discipline framework.

The Indian parliament enacted a bill in 2003 that became known as the FRBM act.

RBI MONETARY POLICY

The monetary policy refers to the central bank policy about the use of financial instruments under RBI’s control to standardise magnitudes such as

• availability of credit
• interest rates, and
• money supply.

All this to achieve the ultimate objective of economic policy mentioned in the Reserve Bank of India Act, 1934.

The chief aim of fiscal policy is to maintain price stability while pursuing the goal of growth. For long-term growth, price stability is essential.

Amending the RBI’s 1934 Act in May 2016 laid the legal groundwork for adopting the flexible inflation targeting agenda.

The government made a committee to review the FRBM Act 2016 in May 2016, led by NK Singh. According to the committee, the government should aim for a fiscal deficit of 3% of GDP in the years leading up to March 31, 2020, then reduce it to 2.8 percent in 2020-21 and 2.5 per cent by 2023.

After consulting with the Reserve Bank, the revised RBI Act also calls for the Indian government to set the inflation target once every five years.

The Central Government has set a target of 4% Consumer Price Index (CPI) inflation in the Official Gazette from 5 August 2016 to 31 March 2021, with a higher tolerance limit of 6% and a lower tolerance limit of 2%.

The Central Government also announced the following factors that contribute to the failure to meet the inflation target:

• For any three consecutive quarters, average inflation exceeds the upper tolerance level of the inflation target.
• For three quarters in a row, the average rise has been less than the lower tolerance threshold.

The modified RBI Act explicitly grants the Reserve Bank of India a legislative mandate to operate the country’s policy framework.

The goal of the monetary policy framework is to determine the policy repo rate based on the current and changing macroeconomic condition. There are strategies to adjust money market rates at/around repo rates by changing liquidity conditions.

TARGETS OF THE FRBM ACT

Initial FRBM Targets (to be met by 2008-09)

• Revenue Deficit Target – By March 31, 2009, the revenue deficit should completely get eliminated. The annual reduction target got set at 0.5 per cent of GDP.
• Fiscal Deficit Target – By March 31, 2009, the fiscal deficit should get reduced to 3% of GDP. AT The annual reduction target got set at 0.3 per cent of GDP.
• Contingent Liabilities – The Central Government shall not make incremental guarantees totalling more than 0.5 per cent of GDP in any fiscal year beginning in 2004-05.
• Additional Liabilities – By 2004-05, additional liabilities (including external debt at current exchange rates) should get reduced to 9% of GDP. Every year after that, the minimum annual reduction target will be 1% of GDP.
• RBI purchase of government bonds – to cease from 1 April 2006. It indicates the government did not borrow directly from the RBI.

DID THE GOVERNMENT MEET THE TARGETS?

No, In 2007–08, the government was able to reduce the fiscal deficit to 2.7 per cent of GDP and the revenue deficit to 1.1 per cent of GDP by enacting the act. However, it didn’t meet the objectives.

The global financial crisis (2007-08) prompted the government to inject resources into the economy in fiscal stimulus in 2008. As a result of the global financial crisis, fiscal targets had to get temporarily postponed.

Amendments in the FRBM act

Significant changes were made in 2012 and 2015, resulting in a reduction in the target realisation year.

In addition, a new concept known as Effective Revenue Deficit (E.R.D.) got introduced.

The ‘Medium Term Expenditure Framework Statement’ requirement was added via amendment in FRBMA.

FRBM Targets after Amendment to FRBM Act in 2012 (to get achieved by 2015)

• Revenue Deficit Target – By March 31, 2015, the revenue deficit should get eliminated. The annual reduction target got set at 0.5 per cent of GDP.
• Fiscal Deficit Target – By March 31, 2015, the fiscal deficit should get reduced to 3% of GDP. The annual reduction target got set at 0.3 per cent of GDP.

FRBM Targets after Amendment to FRBM Act in 2015 (to get achieved by 2018)

• Revenue Deficit Target – By March 31, 2018, the revenue deficit should get eliminated. The annual reduction target got set at 0.5 per cent of GDP.
• Fiscal Deficit Target – By March 31, 2018, the fiscal deficit should get reduced to 3% of GDP. The annual reduction target got set at 0.3 per cent of GDP.

HISTORY OF BUDGET IN INDIA

When India was still under British colonial rule, the first budget got presented on April 7, 1860, by India’s then-Finance Minister, James Wilson.

• On November 26, 1947, the first Finance Minister of Independent India, Sir R.K. Shanmugham Chetty, presented the first Union Budget of Independent India. It is worth noting that the first Union Budget got introduced amid widespread riots caused by India’s partition.
• The budget was intended to last seven and a half months, after which the next budget would get implemented on April 1, 1948. It was the first Union Budget in which both India and Pakistan agreed to use the same currency until September 1948.
• Finance Minister Sir Chetty resigned, and the responsibility eventually passed on to John Mathai, who was responsible for the Union Budgets of 1949-50 and 1950-51. 1947-48 was the first time a budget got prepared for a United India that included all princely states.

Latest FRBM Targets

The most recent FRBM legislation requirements compel the government to restrict the fiscal deficit to 3% of GDP by March 31, 2021.

Under specific conditions, the Act allows for a deviation from the annual fiscal deficit target.

WHAT FISCAL TARGETS SHOULD WE ADOPT?

Fiscal rules should prioritise macroeconomic stability, with relevant targets including the fiscal deficit, primary deficit, and debt/GDP (gross domestic product) ratio. The committee has concentrated on the fiscal deficit, the debt ratio, and the revenue deficit, which, in my opinion, are irrelevant.

Our fiscal deficit and the debt ratio are significantly higher than those of other comparable emerging market countries.

It is irrelevant when things are going well because markets are notoriously forgiving when growth is strong. Because our fiscal deficit and the debt ratio are our weak points, our fiscal rules should attempt to correct both.

ARE THE TARGETS REASONABLE?

• The committee recommends that the Centre’s debt-to-GDP ratio be reduced from 49.4 per cent in 2016-17 to 40 per cent by 2022-23. The debt ratio of the states gets expected to remain around 20%.
• The federal government and the states combined debt gets expected to fall from 68 per cent in 2016-17 to 60 per cent by 2022-23.

• There is no hard and fast rule for determining the debt ratio.

  The combined debt target of 60 per cent for the Centre and states is an improvement from 68 per cent in 2016-17.

  However, it is still remarkably more than the average of around 40 per cent for similarly rated emerging market countries. However, because our growth rate is much higher, a debt ratio of 60% may be acceptable as a reasonable target.

• Fiscal rules that signal that fiscal targets will get adjusted based on actual growth performance will boost credibility.

  Perhaps the new Act should explicitly allow for adjusting medium-term fiscal deficit targets every two years for reflection of revisions in the expected medium-term growth rate.

HOW IS FRBM CALCULATED?

The fiscal deficit calculation can get done by deducting the total revenue received by the government during a fiscal year from the total expenditures incurred during the same period.

The mathematical representation gets as follows:

Total Expenditure – Total Revenue = Fiscal Deficit (Excluding the borrowings)

Fiscal deficits are common in all economies, while fiscal surpluses are uncommon. A large fiscal deficit is not always bad for the economy. It is preferable if the funds get used to building roads, railways, and airports, among other things. After a certain period, these assist in generating revenue for the government.

DOCUMENTS ASKED FOR FRBM

The FRBM Act required the government to submit the following documents to Parliament each year, along with the Union Budget documents:

• Medium Term Fiscal Policy Statement
• Macroeconomic Framework Statement
• Fiscal Policy Strategy Statement

The FRBM Act suggested that the revenue deficit, fiscal deficit, tax revenue, and total outstanding liabilities get projected as a GDP percentage in the medium-term fiscal policy statement.

SCOPE OF FRM ACT IN INDIA

The FRM Act’s implementation has significantly improved India’s quantitative fiscal situation, as evidenced by:

• The introduction of the FRBM Act has improved the federal government’s budgetary performance and the states. The states have significantly outperformed their objectives, and they have done so far ahead of time.
• The Act aided in the strict adherence to the path of fiscal consolidation during the pre-subprime crisis period, creating enough fiscal space for countercyclical fiscal policy to get pursued. In 2007-08, the government used the Act:
  • to reduce the fiscal deficit to 2.7 per cent of GDP, and
  • the revenue deficit to 1.1 per cent of GDP
• However, because of the 2008 global financial crisis, the deadline for implementing the Act’s targets was postponed. The fiscal deficit raised to 6.2 per cent of GDP in 2008–09, exceeding the Act’s target of 3 per cent.

The qualitative aspects of fiscally consolidating the economy, on the other hand, have remained largely elusive:

• There has been a significant reduction in deficits due to reductions in expenditure in the economy’s critical sections such as education, health, etc. It led to the union government’s development spending as a percentage of GDP has decreased over time.
• Examining state revenue accounts for development expenditure reveals that almost all development sectors have declined during the FRBM era.
• Furthermore, according to observations, the government has achieved the deficit targets by manipulating the revenue and expenditure accounts, such as reducing capital expenditure, demanding interim dividends in advance from Public Sector Undertakings (PSUs), etc.

• Furthermore, the FRBM Act disregards the possibility of an inverse relationship between fiscal deficit (fiscal expansion) and bank credit (monetary expansion).

  To guarantee a sufficient money supply in the economy, the fiscal deficit may need to rise if credit growth slows, while the fiscal deficit should shrink if credit growth accelerates.

• Data on money bank credit, supply growth, and GDP show that money supply growth and credit expansion have slowed GDP growth. As a result, the FRBM Act has reduced the fiscal deficit and deprived the growing economy of much-needed investment.

MEASURES TO REDUCE FISCAL DEFICIT

• increasing focus on tax-based revenues and adequate tax-evasion prevention measures
• Disinvestment should get carried out where assets are not getting used effectively.
• Subsidies cut by the government will also help to reduce the deficit.
• Attempt to avoid unplanned expenditures.
• Borrowing from domestic sources
• Obtaining funds from outside sources
• A broader tax base may also aid in reducing the government’s deficit.

Case Study Regarding FRBM Act

UTTAR PRADESH

1. Background

   Profile of the State of Uttar Pradesh

   In northern India, the state is the fifth-largest geographical area (2.41 lakh square kilometres) and the largest population.

   The state’s population increased from 19.98 crores in 2011 to 21.33 crores in 2015. (projected).

   Approximately 39.80% of the state’s population lived below the poverty line, compared to the All-India average of 30% in 2011-12. In 2014-15, the Gross State Domestic Product (GSDP) was Rs. 9,76,297 crores at current prices.

   The literacy rate in the state had risen from 56.27 per cent in 2001 to 67.68 per cent in 2010. (2011 Census).

   At the end of 2014-15, the state’s per capita income was Rs. 45,777.

   Gross State Domestic Product

   All goods and services produced in a country during a given period get counted towards the Gross Domestic Product (GDP).

   The growth of the state’s GSDP is an essential indicator of the state’s economy because it indicates the standard of living of the state’s population.

2. Introduction

   On June 20, 2014, the State Government presented its budget for 2014-15.
   The State Government introduced new schemes with a budget provision of Rs. 20,957 crores, according to the budget speech.

   The State Government also allocated:

   • Rs. 41,538 crores for the improvement and expansion of quality education;
   • Rs. 49,108 crores for infrastructure facilities;
   • It gets estimated that Rs. 25,522 crores will be spent on the welfare of scheduled castes, scheduled tribal groups and other backward classes;
   • Rs. 7,625 crores will get spent on agriculture and other related activities;
   • Rs. 14,377 crores for Improvement and extension of quality in medical, health and family welfare facilities;
   • Twarit Economic Development Programme will get Rs. 1,000 crores.

   It provides an audit perspective on the State Government’s finances during 2014-15 and analyses changes in major fiscal aggregates relative to 2013-14 while keeping overall trends in mind over the previous five years.

   The analysis gets based on the Government of Uttar Pradesh’s Finance Accounts and the information contained therein.

3. Legal Framework

   The Fiscal Responsibility and Budget Management Act, 2003 (FRBMA) is an Act of the Parliament of India enacted in 2003 to institutionalise financial discipline, reduce India’s fiscal deficit, improve macroeconomic management, and improve the overall management of public funds by moving towards a balanced budget.

   The main goal was to eliminate the country’s revenue deficit (and then build a revenue surplus) and reduce the fiscal deficit to a manageable 3% of GDP by March 2008.

   However, due to the international financial crisis in 2007, the deadlines for implementing the act’s targets were initially postponed and then suspended in 2009. Given the ongoing recovery process, the Economic Advisory Council publicly advised the Government of India in 2011 to reconsider reinstating the provisions of the FRBMA.

   The State Government of Uttar Pradesh legislated the Fiscal Responsibility and Budget Management Act, 2004 (FRBM) in February 2004 and laid out a reform agenda with the long-term goal of securing economic growth and stability.

   The State Government was also made responsible under the Act for laying a Medium-Term Fiscal Restructuring Policy in the House alongside the annual budget, establishing five-year rolling targets for fiscal indicators, and making rules for carrying out the Act’s provisions.

   The Government of Uttar Pradesh notified the Fiscal Responsibility and Budget Management Rules in October 2006.

4. Conclusion and Recommendations

   The fiscal deficit exceeded (0.33 per cent) the objective established by the Thirteenth Finance Commission and the FRBM Act of not surpassing 3% of GSDP. However, at the end of 2014-15, the ratio of Total Outstanding Debt (Rs 3,07,859 crore) to GSDP (Rs 9,76,297 crore) was more significant than the Budget Estimate objective (27.80 per cent) but lower than the forecasts (41.90 per cent) made by the Thirteenth Finance Commission and the FRBM Act.

   The annual increase in the fiscal deficit increased from 8% in 2010-11 to 37% in 2014-15, indicating an increased fiscal imbalance. However, the declining trend in the fiscal liabilities-to-revenue-receipts ratio (i.e. 202 in 2010-11 and 159 in 2014-15) indicated improved debt sustainability in the state.

CONCLUSION

The FRBM Act aims to promote long-term macroeconomic stability by creating budget surpluses, careful debt management, borrowing limits to reduce deficits and debt, increased transparency, removing fiscal obstacles, and establishing a medium-term budgetary framework.

Though the Act’s primary goal is to reduce the deficit, an important goal is to achieve intergenerational equity in fiscal management. It is because when there are large borrowings today, they must get repaid by future generations. However, the benefit of high spending and debt today goes to the current generation.

Achieving FRBM targets ensures intergenerational equity by reducing the debt burden of future generations.