FRBM recommendations: Why blind obsession for fiscal deficit targets could hurt growth

The Fiscal Responsibility and Budget Management (FRBM) Act of 2003 was aimed at putting certain checks on government spending which was spelt out in terms of targets set for the fiscal and revenue deficit ratios. This was applied for both the Centre and states, and while the states have largely followed these rules on the fiscal deficit front since any aberration requires clearance, the same has been flexible for the central government.

There has been in parallel, some debate about whether or not it makes sense to have rigid targets to begin with as it weakens the power of the government to bring in a stimulus when required if bound by these rules. One may recollect that following the financial crisis India was able to maintain growth due to the fiscal and monetary stimuli provided by the government and RBI. While there are always arguments on both sides, the solution was left to the new FRBM Committee to find which has recently submitted its report.

Representational image. Reuters

Representational image. Reuters

In short the committee recommends that the fiscal deficit ratio should be brought down to 2.5 percent of GDP by FY23, which is hence a five year target. The revenue deficit is to come down to 0.80 percent by this time period and hence there is acceptance that practically speaking the revenue deficit cannot be nil or the account be in surplus. Another dimension added is that the debt to GDP ratio should be 60 percent with Centre’s ratio at 40 percent and states at 20 percent. There are some escape clauses which allow the government to exceed the fiscal deficit number on account of catastrophes, major structural reforms, fall in GDP by 300 bps below average for four successive quarters etc. But here too the deficit should not breach the 0.5 percent mark.

These rules are always good to have as governments have tended to walk this path in the past to the extent possible. However, the escape routes so defined would always be open for interpretation, which in a way is good as it provides some flexibility. But suppose governments decide to adhere to these rules one of the challenges would be implementing certain schemes like Ujwal Discom Assurance Yojana (Uday) which applies to states. Presently, Uday addresses the issue of debt overhang of discoms by shifting the debt to the state government. The states have been provided forgiveness on this score in terms of the fiscal deficit number. However, the debt gets transferred to the liabilities of the state which will come in the way of the 20 percent ratio that has been targeted. Now states would be less willing to do any such debt restructuring in future if these rules were applied. Alternatively, the same has to get classified under the ‘major structural reform’, which then becomes an escape route and will defeat the purpose of having such targets.

Another issue is debt waivers. Presently both the Centre and state have indulged in such schemes which have a bearing on the fiscal deficit under ceteris paribus conditions. States have to rethink such issues because it can lead to a breach in the deficit though it can still be justified as a response to the clause of ‘severe collapse of agriculture’.

Therefore, in terms of both the debt ratios and fiscal deficit numbers, the new FRBM leaves the rules open to interpretation, which in a way is good from the practical view point. But, then it does not appear to be very different from the existing FRBM except for new ratios being specified with different terminal periods for targeting. Hence, in a way it may not be adding anything new to the existing dispensation.

An issue which could have been considered is the accounting practice of the Budget. Presently it is based on actual flows and is not on an accrual basis. The problem really is that governments are able to roll over expenses to the next year to show that they have met the target of fiscal deficit, when in fact the expenditure is pushed to the next year. For example, a fuel subsidy would be paid to the OMC in April rather than March and hence the budget will end up showing a lower expenditure. The OMC works on an accrual basis and will show the subsidy as income earned, and hence this is a win-win situation. To avoid such accounting practices, the FRBM Committee could have made some recommendations.

The Indian economy like other countries is quite inextricably tied up with global economic winds. Growth has tended to be influenced by these forces as well as domestic developments and requires proactive stance from the government. For the last three years growth has been stifled mainly due to the absence of spending which has led to large excess capacities in most industries. Infrastructure has been hit by various political controversies to begin with and subsequently by the NPA issue. Hence, the only entity which can spend is the government as it is also able to borrow at the lowest possible cost which is at least 200-250 bps lower than what a AAA-rated corporate can access funds.

Against this background, the government should have the flexibility to spend more on projects. Even the present economic growth rate of 7 percent is not convincing, though in line with the trend, growth rate requires a push from the government.

Therefore, ideologically setting such limits is not a great idea and should at best be indicative so that governments help to bring about growth rather than work only at meeting targets. This is happening for state governments where they meet the deficit targets at the cost of capex as they have several other commitments like salaries, pensions, subsidies, other transfers etc. This definitely is not the best way of conducting fiscal policy.

(The writer is Chief Economist, CARE Ratings. Views are personal)

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Updated Date: Apr 13, 2017 17:03:08 IST

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