Explained: FRBM Act

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There exists a nationwide consensus on the fact that a developing country such as ours needs to maintain its financial deficits in order to sustain the flow of disposable income in the hands of its citizens. In furtherance of the same, the Government of India (GoI) had promulgated the Fiscal Responsibility and Budget Management (FRBM) Act, 2003 to ameliorate the sinking economy of the country, owing to the increasing revenue and fiscal deficits during the late-1980s.

Likewise, even the State governments had enacted the FRBM Act within the framework of their respective legislations, with Karnataka pioneering the promulgation of the Act. Striving to hold the Government accountable for its reckless borrowings, the FRBM Act set an upper threshold of 3% (of the GDP/GSDP) on fiscal deficit and had also placed a ceiling on the Government’s debt and interest payment ratio.

In an attempt to efficiently finance its emergency relief package catered towards treating COVID-19 patients, the State of Kerala had recently proposed to borrow a sum of INR 12,500 crores from the Centre in April 2020. The same insinuates towards the possibility of the State being mandated to follow some strict limitations vis-à-vis its borrowing and/or spending capacities for the rest of the financial year, so as to maintain its fiscal deficit at 3% (of the GSDP), as per the FRBM regulations.

However, an analysis of Kerala’s current financial position has revealed that the State has the bargaining power to borrow a sum of about INR 25,000 crores during the current financial year of 2020-21. Accordingly, the State has asked for a relaxation of the circumscribing regulations pertaining to the maintenance of the fiscal deficit of the FRBM Act. While the overarching public policy concerns associated with the proposal may induce us into adjudging Kerala’s plea as warranted in law, it is only fair for us to meticulously analyse all the factors which are at play in the aforementioned issue.

Analysing Kerala’s proposal: The curious case of FRBM flexibilities

Clearly, the State of Kerala’s demand for relaxation of the FRBM regulations is not the first instance when a State has specifically asked for such flexibilities. Most of these flexibilities are worked through Section 4(2) of the Act, which is commonly referred to as the ‘escape clause’. This clause entitles the Centre with the discretion to exceed the yearly fiscal deficit target when there exists an impending quagmire related to factors related to the security of the nation, war, structural reform(s), calamities, epidemics et al.

Recently, the constant decrements in the corporate tax slabs was identified as an aberration within the structural reform of the Centre, which was considered grave enough to trigger the escape clause. Consequently, the Centre had modified the fiscal deficit cap for the fiscal year 2019-20 at 3.8% (a 0.5% increment over the previous ceiling). Economists have also argued this increment in the previous year necessitates a corresponding relaxation of the cap for 2020-21, (from 3% to 3.5%) to compensate for the spill-over impact of the reforms undertaken in the previous year.

Additionally, during the time of the global financial crisis, the fiscal deficit target saw a deviation of about 3.4% since the Centre was expected to do away with collecting taxes and focus on increasing its expenditure on creating new jobs and funding public projects. All of this was targeted towards countering the ill-effects of the global slowdown of growth which was incumbent owing to the financial crisis of 2008-09. Accordingly, the fiscal deficit thresholds set for various States were also relaxed during that financial year to 3.5% of the GSDP and such relaxations extended to the subsequent fiscal year as well.

With respect to countries’ proclivity towards amending their fiscal deficits during a particular fiscal year, American economist Alan J. Auerbach had presented a paper on fiscal policy in the Conference on “Rethinking Macroeconomics” at the Pearson Institute, in 2017. The paper highlighted that several countries had to recalibrate their fiscal deficit targets when their attempt to adhere to the same exhibited possibilities of a greater damage being caused to the economy. To this extent, even the Indian Finance Bill presented in 2018 had stipulated a few clauses (207-10) which were centred towards amending certain provisions of the FRBM Act. One such clause sought to eradicate the reference to the term ‘revenue balance’ while another focused on doing away with the practice of employing fiscal deficit as an operational parameter, altogether.

Clearly, the State of Kerala had been one of the first states to offer a sum of INR 20,000 crores towards allaying the rigours associated with the outbreak of the COVID-19 on the livelihoods as well as overall growth of the nation. A proposal by which the State now aims to borrow a sum of INR 12,500 crores when it already is in the fiscal position to borrow about INR 25,000 crores during this financial year seems to be a reasonable proposal, which may be approved to trigger Section 4(2) of the FRBM Act.

Objectives of the FRBM Act

Economists such as S. Mazumdar have argued that the objective of the FRBM Act revolved around assuring “inter-generational equity” in fiscal management along with ensuring the presence of macroeconomic stability in the long run. Owing to the losses accruing to the Indian economy due to reckless borrowing by both the Centre and the States, the FRBM Act was enacted to engender some level of accountability and transparency between the Government’s fiscal reforms and its public policies. Accordingly, the FRBM rules so promulgated were announced by the Government in 2004. These rules were stipulated to not only manage the fiscal reforms and policy in India but also to achieve sustained economic growth with social justice.

In addition, the FRBM Act was promulgated to strike a balance between the competing interests associated with public borrowings and taxations. For, in India, the fiscal deficit has been primarily financed through public borrowings which had a corresponding threat of increasing the taxation for the masses in the future. Economists have also conducted several studies wherein they have tried to examine the relationship between Government revenue and Government expenditure. The relationship between the two is often premised on the fact that revenue has a direct impact on the expenditure of the Government. In other words, it is neither desirable to have a high revenue deficit nor a high fiscal deficit to finance expenditure.

Thereby, the broad objective of the FRBM Act is to keep a check on the expenditure incurred by both the State as well as the Central Government in carrying out its policy reform during a fiscal year. Some economists also consider that the Act provides an institutional framework of fiscal consolidation within the Indian regime. For, with the promulgation of the Act, it has become imperative for the federal and the state legislatures to undertake steps towards curbing fiscal deficit, diminishing revenue deficit as well as engendering even greater revenue surplus in the coming years.

Some salient features of the FRBM Act

The FRBM Act has been enacted to ensure a greater transparency within the government machineries as they implement the policy reforms for a particular fiscal year. The Act has 13 Sections and some of them revolve around the Centre’s duty to project certain number of fiscal indicators in its policy statement. In other words, it is imperative for the Centre under the FRBM Act to display four of the fiscal indicators in the medium-term fiscal policy statement. These indicators include revenue deficit (as per % of GDP), fiscal deficit (as per % of GDP), tax revenue (as per % of GDP) as well as the cumulative outstanding liabilities (as per % of GDP). Along with this, the Act clearly sets a limit on the fiscal and revenue deficit for a specific fiscal year, under Section 4 of the Act. It has also been stated that any deviation from the pre-specified fiscal deficit target is not bound to exceed 0.5% of the GDP of that year. 

Furthermore, Section 3 of the FRBM Act deals with the fiscal policy statements which are laid every year before both the Houses of Parliament, along with the yearly financial statement. While handling down these statements, the Act mandates the Centre to also put forward the Fiscal Policy strategy statement, the Medium-term Fiscal policy statement, the Medium-term Expenditure Framework statement and the Macro-economic Framework statement. The Fiscal Policy Strategy statement is the broadest and the most exhaustive of all and is expected to include the strategic priorities of the Central Government, their fiscal policies, their primary fiscal measures along with an account of their current policies in accordance with the principles enlisted in Section 4 of the Act. The Macro-economic Framework statement, as defined in Section 3(5) is expected to contain a detailed assessment of the possibilities of economic growth prospects in the specific fiscal year.

Conclusion

The enactment of the FRBM Act inarguably reflected the legislature’s commitment towards fiscal conservatism. It is apparent that most countries depend on eternal financial assistance to meet their developmental expenses. However, one cannot deny the fact that some of these expenses are unproductive and thereby, fail to generate the required income for the economy.  In light of the points discussed above, an inclination towards accepting the State of Kerala’s proposal for relaxation of the fiscal deficit for this financial year is likely to be discerned.

Clearly, the ongoing pandemic created by the sudden outbreak of COVID-19 is grave enough to be qualified as a national calamity, which also makes it appropriate for triggering the applicability of the escape clause under the FRBM Act. A relaxation of the FRBM regulations is expected to facilitate both the Union as well as the State Government to gradually increase the overall expenditure to tackle the COVID-19 pandemic.

Author: Prateek Joinwal from West Bengal National University of Juridical Sciences, Kolkata.

Editor: Sweksha from Law Centre-II, Faculty of Law, University of Delhi.

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