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Transparency in public finance is a constant preoccupation of modern administrations and citizenries, as the publicity of public expenditure and borrowing, the uniformisation of national accounts, citizen participation in government decision-making, and the introduction of various forms of control of government activity have become the rule rather than the exception in all geographies. In order to respond to mounting demands from the public, key civil servants are required to obtain not only professional qualifications (like university degrees in accounting, law and public administration) but also specific certifications (internal auditing, administrative law, criminal law) and abide by ad hoc codes of conduct. This multiplies the legal and ethical responsibilities of governments and civil servants as well as the implementation of appropriate policy responses.
The Fiscal Responsibility and Budget Management Act, 2003 (FRBMA) is an Act of the Parliament of India to institutionalize financial discipline, reduce India's fiscal deficit, improve macroeconomic management and the overall management of the public funds by moving towards a balanced budget. The main purpose was to eliminate revenue deficit of the country (building revenue surplus thereafter) and bring down the fiscal deficit to a manageable 3% of the GDP by March 2008. However, due to the 2007-8 international financial crisis, the deadlines for the implementation of the targets in the act was initially postponed and subsequently suspended in 2009. In 2011, given the process of ongoing recovery, Economic Advisory Council publicly advised the Government of India to reconsider reinstating the provisions of the FRBMA.
Governments need to balance their political impulse towards populism and the need for sound expenditure management. Highlighting the importance of the Fiscal Responsibility and Budget Management (FRBM) Act and its related targets in ensuring this, Mr. Arun Jaitely, the incumbent finance minister, said: “One of the reasons why the FRBM targets in India were statutorily brought in was really because, in public life and politics, there was always a conflict between populism and financial discipline. Populism is when you act on the spur of the moment and make a sound-good noise which pleases the audience of the day. You earn a few brownie points, and whether you earn votes on that account is still a doubtful proposition. But at the end of the day, you find your accounts have gone haywire and the financial management itself has suffered. We are now located at an important point of history where we can claim we are the fastest growing major economy in the world, which itself brings its own sense of responsibility in our fiscal planning, And that holds true for a private institution, a PSU, or a state or central government itself. The underlying principal behind this financial management is that everybody must learn to live within their means.”
The government in May, 2016 announced the constitution of a panel under Former Revenue Secretary and Rajya Sabha MP N.K. Singh to review the FRBM Act of 2003, as outlined by Mr. Jaitley in his Budget speech. The panel also looked into the possibility of replacing absolute fiscal deficit targets with a target range. The terms of reference (TOR) of the committee includes, (i) the review of the working of the FRBM Act during the last 12 years, (ii) analysing the factors determining the FRBM targets, (iii) examining the feasibility of fixing the range of fiscal targets in the place of fixed numbers and how the range should be determined and (iv) designing the fiscal targets in a counter-cyclical manner varying with credit contraction and expansion. The recommendations of the committee will have far-reaching consequences for calibrating both fiscal and monetary policy and, hence, growth and macroeconomic stability.
According to the N.K. Singh panel, FRBM is to act in tandem with the inflation targeting of MPC (monetary policy committee). The idea thereby is to ensure resource flow to the economy. The MPC has set an inflation target of 4 percent with an upper tolerance level of 6 percent and lower limit of 2 percent.
Unfortunately, the experience of implementing the fiscal rules during the last 12 years does not infuse much confidence and raises serious questions on the credibility of the government in not sticking to the fiscal rules it formulates for itself. The state governments, riding on the generous incentive recommended by the Twelfth Finance Commission, barring the power sector losses, have by and large conformed to the prescribed targets. The exceptions to this have been the states of Kerala, Punjab and Bengal. In contrast, the Union government has observed the rules more in their breach than in conformity. Although the fast growth in tax revenues helped the Union government to achieve substantial fiscal consolidation until FY08, the huge fiscal expansion in the FY09 budget resulted in the severe escalation in both revenue and fiscal deficits. The blame for this was placed on the global financial crisis though the difficulties started with the farm loan waiver, expansion of the rural employment guarantee and the implementation of the pay commission award. This was compounded by the unwillingness of the government to realistically price petroleum products in the wake of sharply increasing international crude oil prices. The subsequent years have seen continued slippages in conforming to both revenue and fiscal deficit targets. Thus, the 3% fiscal deficit target, that had to be reached in FY09, continues to elude and, now, has been postponed to FY19. The government found it impossible to achieve the target of phasing out revenue deficit and instead, created a new target concept of “effective revenue deficit”! The latest attempt is to transfer the capital expenditure liability to special purpose vehicles.
What are the factors that should go into the determination of fiscal targets?
There has been a lot of misinformation that the targets for India were simply copied from the Maastricht treaty. In fact, the Twelfth Finance Commission set the target at 6% of GDP, 3% each for the Union and the states. The 13th Finance Commission revised it at 5.4% as 3% of GSDP for individual states works out to 2.4% of GDP. The reasoning given by the Twelfth Finance Commission for choosing the target of 6% of GDP was that the only sector with a surplus savings over investment is the household sector and only household sector’s financial saving is available for lending to the government, public enterprises and the corporates. Considering that the average household sector’s financial saving was about 10% of GDP during the period from 1993 to 2002, and assuming an acceptable current account deficit at 1.5%, total available funds for lending works out to 11.5%. Containing fiscal deficit at 6% and limiting the lending to public enterprises at 1.5% would leave about 4% borrowing space for the corporate sector. Currently, the financial savings of the household sector has fallen to 7.7% of GDP and with the fiscal deficit of the Union and states for FY17 estimated at 6.5%, additional borrowing from special purpose vehicles (NHAI, NABARD, Railways) estimated at 1% and the public sector claiming another 2%, there is hardly any borrowing space available to the corporate sector. In this situation, RBI will find it difficult to reduce the interest rate and even if it did, liquidity will be a problem unless the agreement to do away with monetising the deficit between the ministry of finance and RBI is abandoned.
The FRBM implementation experience of the past 12 years has a number of lessons to offer. First, the target chosen should provide a comprehensive measure of borrowing by the government. As the Union government has substantially increased the borrowing through special purpose vehicles to undertake public investments, it is appropriate to consider the public sector borrowing requirements (PSBR), in addition to fiscal and revenue deficit targets. At the state level, as the Fourteenth Finance Commission recommended, it is necessary to include the losses and outstanding loans of power distribution utilities in the target variables of deficit and debt. Second, it is necessary to clearly specify the conditions in which the slippages in the targets could occur. Third, the target variables chosen should not only ensure the magnitude of fiscal adjustment but also its quality. Fourth, it is necessary to fix aggregate targets and break them into the targets for Union and states. Finally, an institution to ensure checks and balances such as the Fiscal Council, to monitor the implementation of FRBM—accountable to Parliament—could help to ensure greater legislative accountability. In fact, over 35 countries have set up such an institution and studies by IMF show that this has significantly improved the quality of fiscal policy calibration in these countries.
Admittedly, implementing pro-cyclical fiscal policy has been a problem and the government has suggested the feasibility of having a range of target variables rather than fixing them and varying the targets according to credit contraction and expansion. While this may indeed be desirable, it is important to fix the mean in relation to the household sector’s financial savings to ensure adequate borrowing space to the private sector. In other words, the range could be tried so long as you fix the threshold properly. Unfortunately, the global experience shows that all governments want to spend the maximum they can and there is a danger that the governments will always work on the ceiling of the range. It is important to ensure sufficient safeguards against such a practice.
By: Abhishek Sharma ProfileResourcesReport error
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