On Path to Fiscal Consolidation

What is the issue?

The government has been breaching the fiscal deficit targets time and again.
Understanding the fiscal status in the light of the recent budget and the recent review committee's recommendations is imperative.

What is the FRBM Act?

The Fiscal Responsibility and Budget Management (FRBM) Act was enacted in 2003.
It led to the framing of FRBM Rules in 2004.
Rules - It essentially sets targets for the Central government to ensure fiscal discipline.
The FRBM rules set a target:

for reduction of fiscal deficit to 3% of the GDP by 2008-09 (with annual reduction target of 0.3% of GDP)
for complete elimination of revenue deficit by 2008-09 (with annual reduction target of 0.5% of the GDP)

Amendments - The target of 3% was achieved only once, in 2007-08.
It was thus first postponed and later suspended in 2009, following the global financial crisis.
The FRBM Act was later amended twice, in 2012 and 2015.
In May 2016, the government set up the NK Singh committee to review the FRBM Act.
In this backdrop, the recent budget has reset the target again.

What is the present fiscal picture?

FISCAL DEFICIT - The current Budget has retained the fiscal deficit at 3.5% of GDP.
This is a deviation from the budgeted target of 3.2%.
3.2% itself is a deviation from the stipulated target of 3% for 2017-18 in the amended FRBM Act.
DEBT - The debt-GDP ratio has increased to 49.1% in 2017-18 from 48.7% in 2016-17.
The increase in debt-GDP ratio is against a declining trend observed until recently.
MTFP - As per the requirement of the FRBM Act, a medium-term fiscal policy (MTFP) statement is presented in each Budget.
The statement pertains to fiscal, revenue, and effective revenue deficits, and outstanding debt of the Central government.
A review of the statements highlights missing the targets for all four variables often by big margins.

What are the recent changes in targets?

FISCAL DEFICIT - Budget 2018-19 has proposed amending the FRBM Act again.
This will shift the target of 3% fiscal deficit-GDP ratio to end-March 2021.
DEBT - The general debt-GDP ratio is slated to be reduced to 60% of the GDP by 2024-25.
The Central government debt-GDP ratio is to be reduced to 40% of the GDP by 2024-25.
These targets are based on the recommendations of the FRBM Review Committee.
However, the committee's target of 2022-23 is shifted to 2024-25.

What are the deviations from the recommendations?

FISCAL DEFICIT - The FRBM review committee proposed the fiscal deficit to GDP ratio to be stabilised at 2.5%.
This target is derived in reference to the annual estimate of available investible resources at 10% of GDP.
It comprises of surplus savings of the household sector and sustainable net capital inflows.
Apparently, the government did not accept this and continued with the 3% target.
If 3% target is the case, the government would have continued with the present FRBM Act.
REVENUE DEFICIT - The committee had specified a revenue deficit glide path, reaching 0.8% by 2022-23.
But, no target has been set by the government for revenue deficit in the present budget.
The target of revenue account balance is significant to a country.
It is favourable if a country borrows as long as the entire borrowing is spent on capital spending.
However, in the Indian context, the revenue deficit with some adjustments reflects government dis-savings.
Unless government dis-savings are eliminated, it will be difficult to reverse the trend of a falling savings rate.
FISCAL COUNCIL - The Committee recommended the setting up of a fiscal council.
This is to independently examine the economic case and justification for deviating from the specified targets.
This is to keep a check on unconstrained fiscal flexibility and to prevent the possibly avoidable fiscal risks.
The Central government however did not accept this recommendation as well.

What are the concerns?

FISCAL DISCIPLINE - A slippage margin of 50 basis points implies a delay in reaching the fiscal deficit target by two and a half years.
The government has been missing the fiscal responsibility targets year after year and changing the statutory framework repeatedly.
This questions the credibility of the government’s commitment to fiscal discipline.
EXTRA-BUDGETARY RESOURCES - In the recent budget, government's total outlay for 3 focus areas is 11.6% of GDP.
The focus areas are agriculture and rural livelihoods, infrastructure and education, and health and social sectors.
Notably, budgetary resources constitute only 16.4% of the total outlay.
The remaining 83.6% is to be raised as an extra-budgetary resource.
This will be through the public sector enterprises concerned, special purpose vehicles and other similar institutions.
However, a substantial part of this may only be based on borrowing.
This is because the relevant bodies may have only limited surpluses.
This will be an added borrowing dependence for extra-budgetary resources along with States' borrowing requirements.
Given the already falling savings rate, increased borrowing can put considerable pressure on interest rates.

What is the way forward?

The fiscal deficit rule in India has been honoured more in breach than in observance.
Another year of fiscal slippage can be fatal for the economy.
The fiscal deficit target needs continued vigilance to ensure sustainability for larger fiscal benefits.

Source: The Hindu