Fiscal Responsibility and Budget Management (FRBM) Act

By Sudheer Kumar K|Updated : November 2nd, 2020

Introduction

The large borrowings of the government during1980s had created difficulty in paying even for two weeks of imports resulting in the economic crisis of 1991. Consequently, Economic reforms were introduced in 1991 and fiscal consolidation was one of the key areas of reforms. Though it was a good start, later the fiscal consolidation faltered after 1997-98. The fiscal deficit started rising after 1997-98. Hence the Central Government introduced the Fiscal Responsibility and Budget Management (FRBM) Act, 2003 to check the deteriorating fiscal situation.

FRBM Act

  • The Act provides a legal institutional framework for fiscal consolidation.
  • The Act seeks to ensure inter-generational equity in fiscal management, long-run macroeconomic stability, better coordination between fiscal and monetary policy, and transparency in the fiscal operation of the Government.
  • It specifies annual reduction targets on the Central government’s fiscal indicators- debt and fiscal deficit etc.
  • It prohibits borrowing by the government from the Reserve Bank of India, thereby, making monetary policy independent of fiscal policy.
    • It restricted the Fiscal deficit to 3% of the GDP.
    • Required complete elimination of Revenue deficit.
  • It requires the government to lay before the parliament three policy statements in each financial year:
    1. Medium Term Fiscal Policy Statement (specifies the annual revenue and fiscal deficit goals over a three-year horizon)
    2. Fiscal Policy Strategy Statement and
    3. Macroeconomic Framework Policy Statement.
  • Escape Clause: As per Section 4(2) of the Act, the Centre can exceed the annual fiscal deficit target under certain exceptional cases:
    • National security
    • War
    • National calamity
    • Collapse of agriculture
    • Structural reforms
    • Decline in real output growth of a quarter by at least three percentage points below the average of the previous four quarters.
  • Centre invoked the escape clause twice so far in the following cases:
  1. The global financial crisis in 2008-09:
    • The government had to stimulate the economy with a huge fiscal deficit (6.2%) against the goal of 2.7%
  2. Budget 2020-21:
    • In 2019-20, the Government reduced Corporate Taxes from 30% to 22%:
    • Government cited this as structural reform and invoked ‘escape clause’ and increased the earlier fiscal deficit reduction target by 0.5% from 3.3% to 3.8% for 2019-20 as permitted by N.K. Singh Committee.
    • Finance Minister also mentioned the revision of the fiscal deficit target from 3% to 3.5% for the year 2020-21.
  • In order to impart fiscal discipline at the state level, the Twelfth Finance Commission incentivised states through conditional debt restructuring and interest rate relief for introducing Fiscal Responsibility Legislations (FRLs). All the states have enacted their own FRLs.
  • The rules for implementing the FRBM Act were notified in July 2004. The rules were amended in 2018, and most recently to the setting of a target of 3.1% for March 2023.
  • NK Singh committee:
    • It was set up in 2016 to recommend that the government should target a fiscal deficit of 3% of the GDP in years up to March 31, 2020, reduce it to 2.8% in 2020-21 and to 2.5% by 2023.
    • It recommended the following targets:
      • Debt-to-GDP ratio of 38.7% for the central government, 20% for the state governments together,
      • Fiscal deficit target of 2.5% of the GDP
      • Revenue deficit of 0.8% reducing 0.25% points each year
      • Steady target of 3% from FY18 to FY20
      • Certain strict 'escape clauses' which will allow the govt. deviate from the target is 0.5%
      • Suggested the setting up of a ‘fiscal council’ an independent body, which monitors the government’s fiscal announcements for any given year.

Conclusion

Any Economy can have different internal and external challenges always but circumventing meeting the fiscal deficit reduction goals showing them as a reason is unwarranted. Also, the Government shall show commitment in implementing the N.K. Singh recommendations.

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Sudheer Kumar KSudheer Kumar KMember since Sep 2020
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