Twists and turns in Fiscal Responsibility Act

When such a review to the Act has taken place, the Finance Ministry has received greater breathing room

The Act has gone through four Finance Ministers- Jaswant Singh, Pranab Mukherjee, P. Chidambaram and Arun Jaitley.

Finance Minister Arun Jaitley’s statement during his Budget speech that “a time has come to review the working of the FRBM (Fiscal Responsibility and Budget Management) Act” is not the first time that governments have tried to create more wriggle room out of the strict fiscal parameters set in the Act.

The idea of a Fiscal Responsibility Act was first introduced by then Finance Minister Yashwant Sinha (incidentally, the father of the current Minister of State for Finance Jayant Sinha) in his Budget speech of 2000-01. “For medium-term management of the fiscal deficit we also need the support of a strong institutional mechanism embodied in a Fiscal Responsibility Act,” the senior Mr Sinha said at the time, adding that he had set up a committee to examine the issue and recommend how to best move forward.

This committee, under the chairpersonship of the then Secretary of Economic Affairs E.A.S Sarma, referred to fiscal rules of around 20 countries including those of the US, Canada, Japan, Brazil, South Africa and the European Union. After its deliberations, it came up with a draft Bill which mandated reducing the revenue deficit to nil within five financial year starting April 1, 2001 and also bringing down the fiscal deficit to two per cent of the GDP in the same period.

Major concern

However, a major concern surrounding the draft Bill at the time was not the strictness of these fiscal parameters, but the Bill’s provision for a Fiscal Management Review Committee. This committee was to be chaired by the Prime Minister and had the Finance Minister, Speaker, Chairman of the Lok Sabha, the Leaders of the Opposition in both houses of Parliament, the Comptroller and Auditor General (CAG) of India and the Governor of the Reserve Bank of India as its members.

The CAG immediately disagreed with the creation of such a committee and placed its dissent on record in the E.A.S Sarma Committee Report. “The proposed committee will be an encroachment on the prerogative of the finance minister, who has to present reports/policy statements of the government to the Parliament for its consideration and debate. In fact, such a body shall create unanticipated legal and procedural problems,” the CAG’s dissenting note said.

“[The] setting up of a Fiscal Management Committee through statute is not consistent with the existing Constitutional arrangements and it goes against the basic structure of the Constitution,” the note added.

Oversight

In other words, such oversight would hamstring the finance minister and would lay unnecessary pressure on his ability to meet the FRBM targets.

The Fiscal Responsibility and Budget Management Bill, 2000 was examined by a Standing Committee on Finance, chaired by Shivraj Patil, which placed its recommendations in front of Parliament in December 2000.

The overall view of the Committee was pretty straightforward. Planned deficit financing is a good idea as long as it creates productive assets, according to the report. “However, the numerical ceilings and the time frame set for attaining the said levels induce excessive rigidity into the decision making depriving the Governments of the flexibility needed to respond to the exigencies in an appropriate manner, to serve the national interest best.” More interesting than this view was the number of dissenting notes—no less than four—and the vehemence of dissent the issue brought forth. One note, in particular, exemplified all that was considered wrong with the FRBM Act.

Political will

“The objective of this Bill is to impose some self-discipline on the government on fiscal matters. But this is no more than an eyewash. If the government has the required political will to control deficit, then it does not need any legislation. If, on the other hand, it lacks political will in this matter, no amount of legislative self discipline would work,” according to the dissenting note, by Biplab Dasgupta and Prabodh Panda, both Members of Parliament.

“If the government can pass the Bill, say tomorrow, it is equally possible for it to withdraw the Bill day after tomorrow. As long as the Government enjoys majority in Lok Sabha, it can make or unmake a Bill umpteen times,” the note added, understandably oblivious of Parliamentary politics post-2010.

In any case, the FRBM Bill was passed by Parliament in 2003 and put into place in 2004. The targets set by the Act for the government was to bring the revenue deficit down to zero and the fiscal deficit to below three per cent of GDP by 2008-09, among other procedural rules. A committee was formed under Vijay Kelkar to put forth a roadmap for the implementation of the Act.

Flexibility

The 13 Finance Commission reviewed the Act in 2009 and reiterated the view of Shivraj Patil Standing Committee report that the numerical ceilings needed greater flexibility and that there was a need to keep in the mind the effect global economic events could have on these targets.

“First, we recommend that the MTFP (Medium Term Financial Plan) make explicit the values of the parameters underlying expenditure and revenue projections and the band within which these parameters can vary while remaining consistent with FRBMA targets. This will enable the government to make an evidence-based case for relaxation of these targets, should such circumstances arise,” according to the 13 Finance Commission’s report’s chapter named ‘Revised Roadmap for Fiscal Consolidation’.

“Second, we recommend that the FRBMA specify the nature of shocks that would require a relaxation of FRBM targets. These would include agro-climatic events of a national (rather than regional or state-specific) dimension, global recessions impacting the country’s exports and shocks caused by domestic or external events like asset price bubbles or systemic crises in important sectors like the financial markets,” it added.

Following these recommendations, the Act was amended via the Finance Act 2012. One of the amendments was that, along with the Medium-Term Fiscal Policy Statement, Fiscal Policy Strategy Statement and the Macroeconomic Framework Statement, the Central Government would also have to lay a Medium Term Expenditure Framework Statement before Parliament.

Big change

Another big change made in the amendment was that, instead of targeting the revenue deficit, the FRBM Act would target a new concept, the ‘effective revenue deficit’—the difference between revenue deficit and grants for creation of capital assets. In essence, this placed capital expenditure out of the purview of the revenue deficit.

Finally, the dates by which the effective revenue deficit and fiscal deficit targets were to be met were extended. The effective revenue deficit was to be eliminated the fiscal deficit was to be below three per cent by March 2015.

These targets were once again revised in the Finance Act 2015, pushing the dates of achievement to March 2018.

Finance Minister Arun Jaitley’s plan to review the FRBM Act, and Minister of State for Finance Jayant Sinha’s statement on Tuesday about the need for a “dynamic, more flexible approach to fiscal management” should be seen as yet another step in this long chain of events.

It is telling that Mr Jaitley wants a review of the Act to take place. History shows that almost every time such a review or amendment to the FRBM Act has taken place, the Finance Ministry has received greater breathing room to achieve its fiscal targets.