INDEPENDENT FISCAL COUNCIL
India requires strong institutions for macroeconomic governance to manage the vagaries of business cycles and contain high inflation. In the monetary policy sphere, this was addressed by the recently constituted Monetary Policy Committee that aims to use 'inflation targeting' as a tool to ensure macroeconomic stability.
A similar focus is needed with respect to the fiscal policy in order to ensure sustainable budgeting. The emphasis on making government budgets sustainable is because it promotes equity across generations. Targets for debt and deficits were defined with reference to the Fiscal Responsibility and Budget Management (FRBM) Act, which came into effect in 2003. These rules, however, were modified thrice over the years and were not complied with in practice. Past year too, citing drastically reduced fiscal space and to account for the need to increase public investment, the finance minister decided to push the deadline for achieving the 3% deficit target to three years from two years.
It is in this context only that the 14th Finance commission recently questioned the government's failure to act on its recommendation of constituting an Independent Fiscal Council (IFC). Such a council is to evaluate the government budget announcements and forecasts and ensure that the government remains committed to the fiscal discipline laid out in the FRBM Act or similar statutes passed by the parliament.
Need for such a body
The need for such an independent body arises from the fact that since the FRBM Act came to force in 2003, there have been four pauses in the deficit targets enshrined in it and several instances of targets being out-rightly flouted. At times centre has resorted to creative accounting in order to cover up the breached fiscal discipline targets.
Also, six times in past eight years, revenue forecasts of government have fell short by around 10% due to errors of overestimation.
The need for an independent body also arises from the fact that while union government oversees the fiscal targets of the states, there is no regulator over its own fiscal decisions. Though one can argue that the Auditor General monitors the FRBM Act, it is post facto assessment and hence does little to enforce fiscal discipline.
It is in this context that there is a need for an Independent Fiscal Council.
Advantages of such a body
Presence of an independent regulator in the fiscal policy will boost the confidence of the investors. If investors are assured of government borrowings and spending in the economy, they can better plan their investments.
Sustainable fiscal health with well defined targets and an independent regulator will also boost the credit rating of India.
On a macroeconomic scale, sustained fiscal deficit will ensure that private investments are not crowded out and cheap loans are available to investors thereby ensuring sustainable inflation levels in the economy.
Role of such a body
The IFC will have the job of deciding on the deficit in the budget on the basis of an explicit GDP growth forecast. The government’s budget must match the IFC’s budget balance decision for the most likely growth forecast. Thus, all fiscal authority regarding spending and revenue decisions stay with the finance ministry. The level of debt and deficits that is permissible has to be delegated to the IFC, which is to be a body of independent experts. Such experts ought to be appointed for a long duration so as to make them fully independent. In this way, fiscal policy that has the tendency to be over-expansive and have detrimental long-run impacts will be made sustainable through ex ante control by the IFC.
Regarding fiscal deficit, the IFC should adopt a range of deficit target just like the monetary policy committee. A range of targets instead of fixed figures is essential to give the government necessary policy space to deal with unforeseen volatile situations like global uncertainties, disaster, war etc.
The IFC should strictly monitor the deficit targets and hold the government of the day accountable for their breach and also seek a deadline and course of action to make amends for them.
(Students should keep in mind that the IFC is still a proposal by certain experts (including the finace Commission) and hence should keep a tab on developments in this regard)