Union Budget and fiscal deficit - What happens to FRBM - Motilal Oswal

Union Budget and fiscal deficit - What happens to FRBM

The Fiscal Responsibility and Budget Management (FRBM) Act was passed in 2003 during the tenure of the Atal Behari Vajpayee government. The crux of the FRBM was to keep a target within which the fiscal deficit was to be curtailed and explore ways to eliminate the revenue deficit completely.

The FRBM had the following agenda..

To target a phased reduction in fiscal deficit and revenue deficit to eventually convert the revenue deficit into a revenue surplus

Setting annual targets for reduction of fiscal deficit and revenue deficit and also for contingent liabilities, so that actual liabilities are  not substituted with contingent liabilities

The government shall not borrow from the RBI nor will the RBI subscribe to the primary issues of the central government (this was effective from 2006)

The revenue deficit and the fiscal deficit will be allowed to exceed the targets only the grounds of national security or some major calamity

The purpose of the FRBM is also to ensure cross-generational equity. For example, when expenditure is incurred the benefits go to the current generation. But debt is repaid by future generations. That is also one of the key ideas of FRBM Act.

Subsequent amendments to the FRBM Act..
While the FRBM Act was passed in right earnest, there were a lot of inherent contradictions in the Act. For example, there was an exceptionally bad year like 2008 when government across the world had to resort to pump priming. Sticking to fiscal responsibility at that point would mean that you lose out on the counter-cyclical benefits of fiscal policy, which entails pump priming the economy when growth needs to be propped up. There were notable amendments to the FRBM Act in 2012 and later in 2015. Instead of fixed targets for each year, the amendment envisaged a situation where a medium term expenditure framework was worked out which would set rolling targets for 3 year time frames.
Target dates for the different levels of fiscal deficit were also modified in 2012 and 2015. For example, in 2012 the target date for reaching revenue surplus was extended to 2015. Subsequently, in 2015, the target date to reach 3% fiscal deficit was extended to March 2018. The last budget 2017-18 further extended the deadline to touch 3% fiscal deficit to 2018-19.

Why FRBM has come under the scanner in 2018 budget?
For the fiscal year 2017-18, the fiscal deficit is already under pressure. The original target was to touch 3.2% fiscal deficit by 2018 March and 3% by 2019 March. For the fiscal year 2017-18, the government has already touched 112% of its full year fiscal deficit target by November itself. With four months still left, India could end up with a fiscal deficit in the rage of 3.5% to 3.7%. Most likely even the 3% target for March 2019 looks dubious. The fiscal deficit has overshot due to the following reasons..

The government has made a major outlay for infrastructure with focus on roads and expressways. In fact, the infrastructure outlay has doubled between 2014 and 2017 with most of the increase in outlay coming in the recent fiscal year itself.

The RBI dividend has come down sharply this year around. Against the RBI dividend of over Rs.60,000 crore last year, this year it has halved to less than Rs.30,000 crore. While there was a big bill for the RBI due to printing of new notes post demonetization, the RBI had also transferred Rs.13,000 crore to a contingency fund for future exigencies.

The tax collections also took a hit on the indirect taxes front. In July 2017, most of the indirect taxes like excise duties, service tax, sales tax, VAT were all subsumed under the GST. Only customs duty was left out of the GST ambit. As a result the government has been facing a lot of teething problems. The GST collections averaged Rs.91,000 crore in the first 3 months but from October onwards the collections fell sharply close to Rs.80,000 crore. Of course, this was more due to the plethora of rate cuts and refund demands. But then it does put a strain on resources of the government.

What could be the way forward on FRBM?
There are a few distinct possibilities and this budget could be a starting point for these shifts. To begin with, the government is likely to use its 50 basis points leeway in both the years. Secondly, it is also possible that the definition of deficit may be changed from the central deficit as it is today to a consolidated deficit of the centre and states. This will not only give a higher fiscal deficit leeway but also give a more realistic picture of the deficit. Lastly, we also see the distinct possibility of the FRBM being scrapped and being replaced with a new Act altogether. The new act will not only focus on reduction of fiscal deficit but also on using fiscal deficit as a lever to create growth.
The FRBM is likely to undergo a major shift in Union Budget 2018. On the one hand the scope of the Fiscal engagement will expand from mere curtailment to more of managing the fiscal deficit by balancing growth and borrowings. Secondly, the new FRBM Act will also be used to give a clear signal that going ahead the fiscal policy is likely to matter a lot more than monetary policy. In terms of government policy, fiscal policy could now emerge as the new pivot. The new FRBM could be used to signal that shift!

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