Budget 2019: Adhering to 3.3% target is not sacrosanct, fiscal management allows for enough flexibility to make numbers look agreeable

The fiscal deficit target has become a sacrosanct number for various reasons. First, there is a Fiscal Responsibility and Budget Management (FRBM) Act which talks of a glide path which is ostensibly taken seriously and there is immense debate on these possibilities every year.

Second, it is perceived as being the quickest indicator of fiscal discipline being pursued in the country.

Third, all international agencies track this number across various countries and raise a red flag when the deficit is high. It is important, hence, for any global benchmarking.

Fourth, all fiscal policies relating to taxation and expenditure hinge on this number being attained and are crafted accordingly.

While we are aware of the 3 percent ideal target which has to come down to 2.5 percent by FY23, one is not sure about the sanctity of this number. Why could not this number be 5 percent or 2 percent or zero percent? For sure, when the euro came into existence the number of 3 percent was a benchmark and hence there is some rationalisation for this target.

The important thing is, whether or not this is relevant in case we never seem to be meeting the target consistently? This question is pertinent because the FRBM Act of 2003 spoke of achieving this target by 2008-09 with 0.3 percent reduction every year, but the number has been higher in all years except 2007-08 when it came in at 2.54 percent.

There have been several amendments made to the target year of achieving the 3 percent number and hence while the Budgets move asymptotically towards this number, we are not quite getting there. Therefore the question is, whether or not at the end of the day does it matter? This is important because if there is no legislative rule binding on this number, as things cannot possibly come to a standstill because the 3 percent mark has been skipped, the target may be an empty one.

The FRBM has stated in both the versions (N K Singh-headed committee had its ideas in 2017), that if this target is not being adhered to, there has to be a mid-term review and an explanation given as to why the government has not managed the target. It has asked for more transparency in terms of more documents being uploaded on the web site like the MTFP, etc.

But there is no rule to say that the government cannot go beyond the stated number. In fact, the FRBM has also laid down conditions under which there can be a deviation such as a calamity, flood, drought or unforeseen circumstance. Such disturbances should lead to a decline in the GDP growth rate by 3 percent points – which has never happened. Even so the deviation from the fiscal deficit target can be only 0.5 percent. Quite clearly deviations from budgeted numbers have never gone with the GDP growth stipulation.

File photo of Union finance minister Arun Jaitley. PTI

File photo of Union Finance Minister Arun Jaitley. PTI

If one looks at the states, the position is slightly better because if states have to go beyond 3 percent or 3.25 percent or 3.5 percent (the latter two are permitted by the Finance Commission if states adhere to certain fiscal performance parameters) as has been permitted by their FRBM Acts, they need to get permission from the Centre and RBI as this means higher borrowings in the market. But here, too, there have been states that have breached their limits often.

In 2016-17 for example, Punjab had a ratio of 12.3 percent while Rajasthan 6.1 percent, Telengana 5.5 percent and in 2017-18 it was high for Bihar at 7.2 percent, Goa 4.6 percent and Punjab 4.5 percent. While on the aggregate, the 3 percent mark has been maintained, there have been discrepancies within the set of states.

This has been allowed since a large part of the revenue earned by states comes from the Centre and with the GST coming in there would be considerable volatility in these flows. This will necessitate higher borrowings from the market. Therefore, there is separate dispensation given.

This sounds logical as such limits on borrowings cannot be cast in stone. But this will beg the question again as to why should we then have the FRBM targets.


Further, when UDAY (State DISCOM reforms) was brought in, which had the state distribution companies transferring 75 percent of their debt to the government, there was forbearance for two years in the fiscal deficit ratio which were calculated as ‘with’ and ‘without’ UDAY. This meant loading Rs 2.3 lakh crore of PSU debt on the state government liabilities as these were book entries made good by making the creditors now hold UDAY bonds without any new debt being raised. In a way this was an escape clause.

The question to be asked again then is that, if such variations are accepted and common, then does it make sense to have a target of 3 percent? The answer surprisingly is yes, because having a target imposes some sort of discipline on governments to keep their borrowings down.

Budgeting is an inexact science where one is never sure of how the economy performs and tax collections move. At the same time, expenditures have to be evenly spread during the year to ensure that all necessary payments are made on time while flexibility afforded to discretionary expenditure. This is why they end up cutting capex to meet the fiscal targets set for the year.

Counterintuitively speaking, in case these targets did not exist, there would have been indiscipline as governments would have fewer restraints. Therefore, in a way, states have to work out the best points on the trade-offs. Also, interestingly, there are different ways in which governments can manage their accounts to show that the deviations are under control. Off-budget borrowings are one way in which PSUs borrow instead of the government.

Another practice is rolling over of expenses so that they get accounted for in the succeeding year instead. This is done for subsidies to show that there is no overspending. Hence, besides the UDAY bonds or recapitalisation bonds which are used to carry out certain programmes, there are other methods of controlling the deficit. Therefore, harping too much on whether or not the 3.3 percent number will be met may not mean much as fiscal management allows for enough flexibility to make the numbers look agreeable.

(The writer is Chief Economist, Care Ratings. He is the author of: Economics of India: How to fool all people for all times)

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Updated Date: Jan 21, 2019 16:08:13 IST

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