India does need a Fiscal Council

Though it is not a silver bullet, it is an important institution needed to complement the rule-based fiscal policy

August 25, 2020 12:02 am | Updated 07:39 am IST

The fiscal situation in India has been under severe stress even before COVID-19 and the novel coronavirus pandemic has only worsened it. The fiscal deficit of the Centre in 2019-20 as estimated by the Controller General of Accounts (CGA) was 4.6%, 0.8 percentage point higher than the revised estimate. For the current year, even without any additional fiscal stimulus, the deficit is estimated at about 7% of GDP as against 3.5% estimated in the Budget due to a sharp decline in revenues. The consolidated deficit of the Union and States could be as high as 12% of GDP and the overall debt could go up to 85%. When off Budget liabilities are considered, the situation looks even more alarming.

While the prevailing exceptional circumstance warrants loosening of purse strings, it is necessary that the government must return to a credible fiscal consolidation path once the crisis gets over.

Also read: Coronavirus to have significant deflationary impact due to demand evaporation, says CEA

Need for transparency

Besides large deficits and debt, there are questions of comprehensiveness, transparency and accountability in the Budgets. The practice of repeated postponement of targets, timely non-settlement of bill payments and off Budget financing to show lower deficits has been common. The report of the Comptroller and Auditor General (CAG) of India in 2018 on the compliance of the Fiscal Responsibility and Budget Management (FRBM) Act for 2016-17, highlights various obfuscations done to keep the liabilities hidden.

These include special banking arrangements for covering arrears of fertilizer subsidy, issuing short-term bonds, unsecured loans and borrowing from the National Small Savings Fund (NSSF) by the Food Corporation of India towards meeting food subsidy and its arrears, financing irrigation projects from the Long Term Irrigation Fund (LTIF) created by the National Bank for Agriculture and Rural Development (NABARD), and financing of railway projects through borrowings from the Indian Railway Finance Corporation (IRFC) are just some examples. We are familiar also with the cases of the Life Insurance of Corporation of India buying out the Industrial Development Bank of India and the Power Finance Corporation buying out the Rural Electrification Corporation (REC) and remitting the money to the government as disinvestment proceeds.

In order to make the Budgets comprehensive, transparent and accountable, the 13th Finance Commission recommended that a committee be appointed by the Ministry of Finance which should eventually transform itself into a Fiscal Council to “..., conduct an annual independent public review of FRBM compliance, including a review of the fiscal impact of policy decisions on the FRBM roadmap” (Paragraph 9.65). The FRBM Review Committee too made a similar recommendation underlining the need for an independent review by the Finance Ministry appointing the Council.

The problem is that a Council created by the Finance Ministry and reporting to it can hardly be expected to be independent. Therefore, the 14th Finance Commission recommended the establishment of an independent Fiscal Council which should be appointed by and reporting to Parliament by inserting a new section in the FRBM Act. Former Deputy Governor of the Reserve Bank of India, Viral Acharya, in his recent book, Quest for Restoring Financial Stability in India , also makes out a case for a bipartisan, independent Fiscal Council.

The mandate

A Fiscal Council is an independent fiscal institution (IFI) with a mandate to promote stable and sustainable public finances. Robert Hagemann (“How Can Fiscal Councils Strengthen Fiscal Performance?”. OECD Journal: Economic Studies, Vol. 1, 2011; p.76) defines a fiscal council as, “…a publicly funded entity staffed by non-elected professionals mandated to provide nonpartisan oversight of fiscal performance and/or advice and guidance — from either a positive or normative perspective — on key aspects of fiscal policy”. These institutions assist in calibrating sustainable fiscal policy by making an objective and scientific analysis.

First, an unbiased report to Parliament helps to raise the level of debate and brings in greater transparency and accountability. Second, costing of various policies and programmes can help to promote transparency over the political cycle to discourage populist shifts in fiscal policy and improve accountability. Third, scientific estimates of the cost of programmes and assessment of forecasts could help in raising public awareness about their fiscal implications and make people understand the nature of budgetary constraint. Finally, the Council will work as a conscience keeper in monitoring rule-based policies, and in raising awareness and the level of debate within and outside Parliament.

Diverse role, more acceptance

According to the International Monetary Fund (IMF), there were 36 countries with IFIs in 2014 and more have been established since. While most of the IFIs are in advanced countries, emerging economies too have also shown growing interest in them. Although their common agenda has been to function as watchdogs, there is considerable diversity in their structure and functions. The important tasks of these IFIs include: independent analysis, review and monitoring and evaluating of government’s fiscal policies and programmes; developing or reviewing macroeconomic and/or budgetary projections; costing of budget and policy proposals and programmes; and presenting policy makers with alternative policy options. Over the years, monitoring compliance with fiscal rules and costing policies and programmes have become major tasks of these councils.

The OECD (2013) has documented the important principles needed for successful fiscal councils under nine broad heads and these are: local ownership; independence and non-partisanship; mandate; resources; relationship with legislature; access to information; transparency; communication and external evaluation. These principles are important, ensure autonomy, being unbiased, transparency, and effective and accountable Councils.

How effective have these institutions been? A study by the IMF (“The Functions and Impact of Fiscal Councils”, July 2013), documents that the existence of IFIs is associated with stronger primary balances; countries with IFIs tend to have more accurate macroeconomic and budgetary forecasts; IFIs are likely to raise public awareness and raise the level of public debate on fiscal policy. Case studies in Belgium, Chile and the United Kingdom show that IFIs have significantly contributed to improved fiscal performances.

In Belgium, the government is legally required to adopt the macroeconomic forecasts of the Federal Planning Bureau and this has significantly helped to reduce bias in these estimates. In Chile, the existence of two independent bodies on Trend GDP and Reference Copper Price has greatly helped to improve Budget forecasts. In the U.K., the Office for Budget Responsibility has been important in restoring fiscal sustainability. Cross-country evidence shows that fiscal councils exert a strong influence on fiscal performances, particularly when they have formal guarantees of independence.

The final word

When the markets fail, governments have to intervene. What do we do when the governments fail? It is here that we need systems and institutions to ensure checks and balances. In that respect, a Fiscal Council is an important institution needed to complement the rule-based fiscal policy. Of course, it is not a ‘silver bullet’; if there is no political will, the institution would be less effective, and if there is political will, there is no need for such an institution.

That is also true of the FRBM Act. While we cannot state that the FRBM Act has been an unqualified success, it has also not been an abject failure either. The counterfactual will show that things would have been much worse without it, and it has helped to raise the awareness of government, legislators and the public at large. Similarly, the Fiscal Council will help in improving comprehensiveness, transparency and accountability.

M. Govinda Rao was Member, Fourteenth Finance Commission, and former Director, National Institute of Public Finance and Policy, New Delhi, India. The views expressed are personal

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