Topic - Fiscal Responsibility Bill

Prepared By: Pravinkumar P. Sukre

1. Introduction

Fiscal responsibility is the act of creating, optimizing and maintaining a balanced budget.

"Fiscal" refers to money and can include personal finances, though it most often is used in reference to public money or government spending. This can involve income from taxes, revenue, investments or treasuries. In a governmental context, a pledge of fiscal responsibility is a government’s assurance that it will judiciously spend, earn and generate funds without placing undue hardship on its citizens.

Fiscal responsibility often starts with a balanced budget, which is one with no deficits and no surpluses. The expectations of what might be spent and what is actually spent are equal.

In recent years the lack of fiscal discipline has been costly for the Indian economy, as excessive demand arising from large deficits translated into stubbornly high inflation and was partly responsible for large current account deficits. Fiscal discipline should be a priority. An emerging market requires a strong commitment to keeping fiscal deficits in check. New budget legislation, along the lines of the Fiscal Responsibility Bill, but with more teeth, should be instituted.

The Fiscal Responsibility Bill is an financial discipline, reduce 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.

A Bill to provide for the responsibility of the State Government to ensure prudence in fiscal management and fiscal stability by progressive elimination of revenue deficit, reduction in fiscal deficit, prudent debt management consistent with fiscal sustainability, greater transparency in fiscal operations of the Government and conduct of fiscal policy in a medium term framework and for matters connected therewith or incidental thereto.

2. Objectives

The main objectives of the act were:

1. To introduce transparent fiscal management systems in the country

2. To introduce a more equitable and manageable distribution of the country's debts over the years

3. To aim for fiscal stability in the long run

3. Fiscal Responsibility Bill

The FRBM Rules impose limits on fiscal and revenue deficit. Hence, it will be the duty of the Union government to stick to the deficit targets. It also empowers RBI for taking measures to control Inflation. The Act also provides exception to government in case of natural calamity and national security.

The Bill is based on the presumption that the fiscal deficit is the key parameter adversely affecting all other macroeconomic variables. It is argued that lower fiscal deficits lead to higher as well as sustainable growth and higher fiscal deficits apparently lead to inflation. It is also argued that large fiscal deficits may lead to huge accumulation of public debt.

However, many development economists argue that if the fiscal deficit is dominantly in the form of capital expenditure, it contributes to future growth through demand and supply linkages, and in fact can create so much demand in the economy that private investment may crowd-in to supplement autonomous investment. As far as inflation is concerned, it results from an excess of aggregate demand over aggregate supply and there can be higher inflation with low, zero or even positive fiscal accounts.

There is nothing wrong in maintaining large fiscal deficits if resorting to public debt is made only to meet investment requirements as long as their social rate of return is higher than the rate of interest. Deficit per se is not bad as the Countries economy is a demand-constrained economy. Due to existence of underemployment of resources and production at much less than its optimal level, the economy can actually sustain a high level of fiscal deficit up to around 7-8 percent of GDP. Even in case of revenue deficit, if it is properly managed will help pumping in purchasing power to the economy and boost demand keeping in mind the persistently low level of inflation during recent years.

In India, it is not the problem of growing deficits, which deserves concern but the composition for these deficits and the way these are being financed. There are many other countries like USA, Canada in the developed world and Argentina, Peru, Brazil among the emerging market economies have such fiscal responsibility legislations.

However, they often try to reduce their deficit through front loaded Centre for Budget and Governance Accountability (CBGA) 5 mechanisms. Still, many countries sustain their huge fiscal deficit without compromising on the development expenditure front.

4. Gross Fiscal Deficit (GFD)

Gross fiscal deficit (GFD) represents the gap between the government’s expenditures (Like Interest, Defence, Subsidies, Plan Expenditure, and Other Capital Expenditure) and its revenues (Like Net Tax Revenues, Non-tax Revenues, Recovery of Loans and PSU Disinvestment other than net borrowings). This gap is met by net borrowing. GFD is the difference between

(i) Aggregate disbursements net of debt repayments (ii) Revenue receipts, recovery of loans, and non-debt capital receipts.

It also indicates the total net borrowing of the government, and the increment to its outstanding debt.

The State Government finances its gross fiscal deficit by (i) Loans from the Centre, (ii) Market borrowings, (iii) Loans from financial institutions/banks, (iv) Provident funds, (v) Reserve funds, (vi) Deposits and advances, (vii) Special securities issued to the NSSF, etc.

Fiscal deficit = Total expenditure (Revenue expenditure + Capital expenditure) – Revenue receipts – Recovery of loans – Other receipt (mainly PSU disinvestment)

5. Revenue Deficit

Revenue deficit refers to the excess of revenue expenditure over revenue receipts. Revenue expenditure, unlike capital expenditure, does not yield financial return. Therefore, one of the golden rules of fiscal policy is to eliminate revenue deficit, if any. On the other hand, surplus in the revenue account can be used to fund capital expenditure and reduce the government’s dependence on borrowed funds.

Revenue deficit = Revenue expenditure (Interest payments + Total Subsidies + Defence expenditure) – Revenue receipts (Tax revenue + Non-tax revenue)

6. Primary deficit

Primary deficit is the gross deficit which is obtained by subtracting interest payments from budget deficit of any country of a particular year. Primary deficit corresponds to the net borrowing, which is required to meet the expenditure excluding the interest payment.

Primary Deficit = Fiscal Deficit – Interest Payment

7. Principles of Fiscal Legislation at the State level

Keeping in view the poor financial position of the State governments, it is argued that there is an urgent need for putting in place fiscal policy rules at the subnational level. While designing any fiscal rule, it is important to keep in mind the internationally accepted principles of fiscal legislation. In view of the above, the Group felt that the model fiscal responsibility bill for the State Governments should be consistent with the following internationally accepted fiscal management principles meant primarily for national governments, but which could also be applied to sub-national governments with appropriate modifications.

1. Transparency is an important aspect in the setting of fiscal policy objectives, implementation of fiscal policy and publication of the public accounts.

2. Stability in the fiscal policy-making process and in the way fiscal policy impacts on the economy is a very crucial element of fiscal management. Accordingly, the Government should operate fiscal policy in a manner that is predictable and consistent with the objective of high and stable levels of growth and employment.

3. Responsibility in the management of the public finances requires the Government to operate fiscal policy in a prudent way, and manage public assets, liabilities and fiscal risks with a view to ensuring that the fiscal position is sustainable over the long term.

4. Fairness requires that fiscal policy should be operated in a way that takes into account the financial effects on future generations, as well as its distributional impact on the current population.

5. Efficiency should be the key objective in the design and implementation of fiscal policy and in managing the assets and liabilities of the public sector balance sheet. The Government should ensure that available resources are deployed optimally and public assets are put to the best possible use.

8. Deficit Rule

The choice of the deficit indicator for laying down the deficit rule is not an easy one. The Group assessed the pros and cons of adopting one or more among the three major deficit indicators,

1. Gross fiscal deficit (GFD), 2. Revenue deficit (RD) 3. Primary deficit (PD).

Major Deficit Indicators of State Governments ((Amount in billions)

Item 1990-98

1998-2004

2004-08

2008-10

2010-11

2011-12

2012-13(BE)

2012-13(RE)

2013-14(BE)

Averages1 2 3 4 5 6 7 8 9 10

Gross Fiscal Deficit

(2.7) (4.1) (2.3) 1,617.0(2.7)

1,614.6 (2.1)

1,683.5 (1.9)

2,152.7(2.1)

2,334.1(2.3)

2,450.5(2.2)

Revenue Deficit

(0.8) (2.5) (0.0) 91.7 (0.1)

-30.5(-0.0)

-239.6(-0.3)

-425.7(-0.4)

-196.3(-0.2)

-477.3(-0.4)

Primary Deficit

(0.9) (1.7) (0.0) 538.2 (0.9)

366.4(0.5)

315.4(0.4)

598.3(0.6)

790.8(0.8)

716.7(0.6)

BE: Budget Estimates. RE: Revised Estimates.Note: 1. Negative (-) sign indicates surplus.2. Figures in parentheses are percentages to GDP.3. The ratios to GDP at current market prices are based on CSO's National Accounts 2004-05 series.Source: Budget documents of the state governments.

2011-12 2012-13 (BE) 2012-13 (RE) 2013-14 (BE)

-1-0.5

00.5

11.5

22.5

Major Deficit Indicators

GFD/GDP RD/GDP PD/GDP

1990-1991

1992-1993

1994-1995

1996-1997

1998-1999

2000-2001

2002-2003

2004-2005

2006-2007

2008-2009

2010-2011

2012-2013

2014-2015 (BE)

6.61

4.72

4.8

6.43

4.74

4.23

4.11

4.81

5.14

5.36

5.48

6

5.73

4.34

3.88

3.96

3.32

2.54

5.99

6.48

4.8

5.75

4.83

4.63

4.12

3.19

2.82

2.67

2.28

2.63

2.7

2.66

2.85

4.17

4.62

3.8

3.8

3.76

4.14

3.11

2.33

1.82

1.49

2.26

2.94

2.1

1.88

2.3

2.16

1.91

9. Fiscal Deficit of Centre and States in India (1990-1991 to 2014-2015)

States Centre

As per above Bar Chart we take Fiscal Deficit of Centre and States in India from 1990-1991 to 2014-2015 and from this we see after Implementing the Fiscal Responsibility and Budget Management Act, 2003 (FRBMA), the government had managed to cut the fiscal deficit of center to 2.54% of GDP and fiscal deficit of states to 1.49% of GDP in 2007–08. However, given the international financial crisis of 2007, the deadlines for the implementation of the targets in the act were suspended. The fiscal deficit rose to 5.99% of GDP in 2008–09 against the target of 3% set by the Act for 2008–09.

10. Fiscal Policy Statements to be laid before the Legislature

The State Government shall in each financial year lay before the House/Houses of theLegislature, the following statements5 of fiscal policy along with the budget, namely:-

(a) Macroeconomic Framework Statement;(b) Medium Term Fiscal Policy Statement; and(c) Fiscal Policy Strategy Statement.

Since the act was primarily for the management of the governments' behaviour, it provided for certain documents to be tabled in the Parliament annually with regards to the country's fiscal policy.

Medium-term Fiscal Policy Statement –

This report was to present a three-year rolling target for the fiscal indicators with any assumptions, if applicable. This statement was to further include an assessment of sustainability with regards to revenue deficit and the use of capital receipts of the Government (including market borrowings) for generating productive assets.

Fiscal Policy Strategy Statement –

This was a tactical report enumerating strategies and policies for the upcoming Financial Year including strategic fiscal priorities, taxation policies, key fiscal measures and an evaluation of how the proposed policies of the Central Government conform to the 'Fiscal Management Principles' of this act.

Macro-economic Framework Statement –

This report was to contain forecasts enumerating the growth prospects of the country. GDP growth, revenue balance, gross fiscal balance and external account balance of the balance of payments were some of the key indicators to be included in this report.

The Act further required the government to develop measures to promote fiscal transparency and reduce secrecy in the preparation of the Government financial documents including the Union Budget.

11. Effects of Fiscal deficit on credit cycle & farmers suicide

On one hand, the hard credit policy and shortage of funds is strangling all economic activity. On the other hand, because of the negligible use of the banking system in rural India, farmers have almost no credit history.

As a result, most of them are simply not in the reckoning for disbursal of loans through the formal banking system. So what options does a farmer have? The local moneylender, of course. At exorbitant and unfair interest rates - but at least it is available. Unfortunately, such borrowing is usually impossible to repay, and usually ends in tragedy, Farmer’s suicide. Is it so difficult to understand now, why more than one hundred and sixty rural districts are in the grip of the Naxal movement today?

So the role of Fiscal Responsibility and Budget Management Act, 2003 (FRBMA) is very important and having priorities for nation for all over growth and development in Agriculture and Rural sector specially.

12. Current Scenario on Fiscal Responsibility and Budget Management Act, 2003 (FRBMA)

Success attracts its own supporters. New government epitomizes the success of merit and dedication. It is not surprising therefore, that supporters, including erstwhile critics, both national and international, are thronging his doorstep for a darshan.

There are visible signs that the public adulation has not gone to his head. He has shot down an attempt to curry favor with him by BJP governments, by revising the textbooks with a chapter devoted to him as a role model. This is very welcome and good news.“But a big governance test will confront him over the next two months”.

Can he deliver a “realistic” budget which does not fudge either revenue receipt or expenditure- two favourite tricks of budget managers to fool the public, adopted by the UPA2 in its last budget? Second, can he reduce the fiscal deficit below the level of 4.9% in 2012-13; the last “normal year” data available. The Fiscal Responsibility and Budget Management Act 2003 targeted a maximum fiscal deficit level of 2% by 2006. We never achieved that level. The best was 2.7% in 2007.  A plan to reach close to this over the next 3 years, by reducing it by 0.5% point every year is sorely needed.

The fiscal deficit in 2013-14 stood at 4.5% of GDP, lower than 4.6% projected in the revised estimate, mainly on account of curbs on government expenditure.The fiscal deficit, the gap between government's expenditure and revenue, in actual terms was Rs 5.08 lakh crore as against 5.24 lakh crore projected in the revised estimate."The fiscal deficit is 4.5% of GDP. Revenue deficit is 3.2% of GDP. Effective revenue deficit is 2% of GDP," the Controller General of Accounts (CGA) said in the provisional accounts for2013-2014. Achieving the fiscal deficit target for 2014-15 of 0.5% point below the 4.9% actual deficit in 2013-14 by reducing the current expenditure of the central government, is the PMs Test in Governance.

But in other part of India, to overcome the financial crisis emerging out of the bifurcation of Andhra Pradesh, the state government has urged the Centre to grant a two-year exemption from implementing the Fiscal Responsibility and Budget Management Act, 2003 (FRBMA) in both Telangana and Andhra Pradesh.

The government needs to find more money, and quickly, to make a variety of investments. If it reduces subsidies significantly(The FY15 budgeted major subsidies are Rs 67,970 crore for fertilizers, Rs 1.15 lakh crore for food (including Rs 88,500 crore for implementation of the food security act), and Rs 63,427 crore for petroleum. ), there is a realistic chance that this can happen. If it doesn't, there is virtually no chance at all. From a strategic perspective, the positive experience with the Fiscal Responsibility and Budget Management (FRBM) Act of 2003 suggests that explicit fiscal rules can help.

In fact, the proposal made in the 2012-13 Budget to embed an explicit fiscal deficit ceiling of two per cent of gross domestic product (GDP) in a new FRBM Act (the first one terminated in 2010) has merit and should be seriously considered by the government, even before it takes a decision on whether to move forward on new legislation. The upcoming Budget provides an opportunity to act aggressively on this front, while still basking in the goodwill generated by its electoral performance.