18 April 2024 : Daily Answer Writing

Q1) Limiting the country’s fiscal deficit is a cherished goal, but the progress towards it is full of hurdles. In this perspective, evaluate the effectiveness of India’s fiscal consolidation framework. Also examine the role of a fiscal council in enforcing fiscal discipline.

(250 Words/15 Marks)

The fiscal deficit is defined as the difference between total revenue and total expenditure of the government. Fiscal deficit is accounted for by new government borrowings which increase public debt.

It is important for a country to limit fiscal deficit due to following reasons:

1. Larger share of government borrowings results in crowding-out of private sector from the limited pool of investible savings in the money market.
2. Cost-push inflation results due to higher interest rates for businesses. Inflation is a ‘tax on the poor’ as its eats into larger share of their income.
3. It results in higher cost of long-term finance for public infrastructure projects.
4. Fiscal profligacy creates high public debt which affects sovereign credit rating, while also creating vulnerability for a balance-of-payment crisis. E.g., the Sri Lankan economic crisis.
5. Healthy fiscal indicators are needed to create room for counter-cyclical measures during economic slowdown such as in pandemic.
6. Fiscal discipline is needed for inter-generational equity in fiscal management.

Fiscal Responsibility and Budget Management (FRBM) Act 2003 and respective State FRBM Acts represent the Fiscal Consolidation legislation in India. Their important aspects are as follows:

1. Fiscal Targets: Target for central government fiscal deficit is 3% of the GDP by FY2021, and for general government debt, 60% of the GDP by FY2025. But the latest medium-term targets (4.5% FD by FY2026) are far in excess of the FRBM targets.
2. Amendments (2012, 2015) to the FRBM Act and suspension of targets (2009) in light of exigencies such as the 2008 GFC have repeatedly pushed the targets.
3. Escape Clause: Exigencies like collapse of agriculture, structural reforms, war, calamity, national security, etc. allow to exceed the annual FRBM target by 0.5%.
4. Role of CAG: Comptroller-and-Auditor General of India reviews compliance with FRBM Act. Its report is laid before both the houses of parliament.
5. Supplementary statements in budget on Macroeconomic Framework, Medium-Term Fiscal Policy-cum-Strategy and Medium-Term Expenditure provide an assessment of the growth prospects of the economy and strategic priorities in the fiscal area.

In light of limited effect of FRBM in inducing fiscal discipline, constitution of a Fiscal Council has been suggested by Finance commission (13th and 14th) and FRBM Review Committee. A fiscal council can bring more discipline in government expenditure in following ways:

1. Fiscal council will improve credibility of budgetary estimates and give more realistic fiscal targets as against repeated postponement of targets.
2. Independence of fiscal council can address the problem of off-budget financing for lower deficits, such as through FCI, NABARD etc. Unbiased report to Parliament will bring in greater transparency and accountability.
3. Scientific and professional assessment of policies’ impact on fiscal roadmap will discourage populist shifts in fiscal policy.
4. It could help provide more justifiable sharing of fiscal burden between center and states through balance between budgetary constraints and functional responsibilities.
5. Suggestions to constitute independent fiscal institutions to complement fiscal rules are backed by IMF and OECD, practices in developed and emerging market economies such as the Congressional Budget Office in the US.

While an independent fiscal council will help in improving fiscal discipline, there is need for growth promoting measures as well. In light of the ongoing pandemic-related slowdown changes in FRBM Act are due, which should reflect balance between fiscal discipline and developmental aspirations.