FRBM Act

“Lord, give me chastity and continence but not yet ” – St. Augustine.

Chastity means the power of self-control. The Economic Survey of 2017 used this phrase to summarise the feelings of every government. They want to control their expenditures by creating rules and legislation, such as the FRBM Act. Despite this, governments are reluctant to reduce their expenditure. They always seek to spend more to fuel growth and distribute benefits to the electorate for political gains.

Adverse effects of Fiscal Slippages:

• Higher government borrowing will lead to Higher interest rates and higher
• Depreciation of private investment: The private corporate sector is crowded out and is not able to borrow. It is said that fiscal slippages up to 0.5% are okay as long as the increase in expenditure is done on developmental projects.
• Bond yields surge: It is a situation when people are ready to buy bonds in RBI auctions at higher rates than the market.
  • High bond yields are indicators of lower credit rating.
  • Fiscal slippages also reduce the benchmark 10-year bond price(of existing bonds). This also means that banks already having G-Secs would incur “Market-to-Market(MTM) loss”.

Deficit reduction:

• Increase in tax revenue (indirect taxes are regressive in nature – impact all groups equally),
• Receipts through the sale of PSUs
• Major thrust: reduction in government expenditure, rationalisation of subsidies., efficient planning of programmes and better administration. [Aadhar administration etc.]
  • Cutting back government programmes in vital areas like agriculture, education, health, poverty alleviation, etc. would adversely affect the economy.

Terms:

Counter-Cyclical: Reducing spending and raising tax during boom & vice versa. Pro-Cyclical Policy: reducing spending and increasing taxes during a recession.

Fiscal Responsibility and Budget Management (FRBM) Act, 2003

In the early 2000s, the government was running a huge fiscal deficit. It was felt that in the long run, government debt has to be eliminated and must be brought to a sustainable level.

Therefore the FRBM Act was passed which institutionalised fiscal discipline and improved macroeconomic management by seeking to:

1. Eliminate Revenue deficit.
2. Bring down fiscal deficit to a manageable 3% of GDP by FY08 from 5.7% of GDP in FY03.

Main Objectives of the FRBM Act

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

• to aim for fiscal stability for India in the long run

Provisions of the FRBM Act

According to the act, the Central government Shall annually lay the “Statements of fiscal policy” along with “Annual Financial statement” and “Demands for Grant” since 2008.

It should contain three documents:

1. Medium-term Fiscal policy statement
2. Fiscal policy strategy statement
3. Macro-economic framework statement

Medium-term Fiscal policy statement:

It mainly contains two things:

1. It sets forth a 3-year rolling target for the prescribed fiscal indicator.
2. It will include an assessment of the sustainability of Revenue deficit; Use of capital receipts(including market borrowing for generating productive assets);

These targets must work upon the following underlying assumptions: The government shall

• Eliminate Revenue deficit progressively from 2005.
• Reduce fiscal deficit to 3% of GDP by 2008. [postponed till 2021, but suspended indefinitely due to COVID-19]
  1. The fiscal limit for most states is 3% of the GDP of States. [as discussed later in this chapter]
  2. However, six states (Odisha, Chhattisgarh, Telangana, MP, Karnataka, and Bihar) have higher limits of 3.5% of GSDP because they have strong overall fiscal positions, as deemed by the 14th Finance Commission’s criteria.
• Not borrowed from RBI.
• Not give guarantees aggregation to an amount exceeding 0.5% of GDP.
• Progressively reduce additional liabilities to 1% of GDP.

Fiscal policy strategy statement:

It provides the following statements:

• Strategic priorities of government Fiscal measures and rationale for any major deviation.
• Evaluation of how current government policies conform with fiscal management principles.
• Specify: Annual targets of assuming contingent liabilities in the form of guarantees & total liabilities as % of GDP.
• If targets exceed: Government shall specify “grounds” & place them before the parliament (both houses), as soon as may be, after such deficit amount exceeds the aforesaid targets.
• A policy of the government for the ensuing financial year relating to taxation, expenditure, market borrowing, & other liabilities, lending & investments, pricing of administered goods & services, securities & description of other activities; such as underwritings & guarantees which have potential budgetary implications.

Macro-economic framework statement:

It provides an assessment related to:

• GDP growth.
• The fiscal balance of the Union government is reflected in revenue balance and gross fiscal balance.
• External sector balance of economy as reflected in CAD of payment.

We can remember these statements as the What, How and Wow factors of the deficit: What the government wants, how would it do it, and how it is performing.

India’s Fiscal Discipline

The implementation of the FRBM Act has been paused four times since its enactment in August 2003, including for a reset of the fiscal deficit target in 2008-09 following the global financial crisis. Its target was revised to FY21.

However, after COVID-19, the government increased its spending exponentially suspending the fiscal deficit target indefinitely.

States of Karnataka, Kerala, Punjab, Tamil Nadu, Maharashtra and UP are among those that have already legislated the required fiscal discipline laws at the state level.

• Overall Debt-to-GDP Ratio: The IMF reports India’s debt-to-GDP ratio at 1%. India tried to reduce it to a level of 60% by 2023, but it couldn’t.
• Central Government Debt: The central government’s debt-to-GDP ratio was 1% in the fiscal year 2023-24 and is estimated to be 57.1% in 2024-25. The Indian government’s target is to reduce its debt-to-GDP ratio to 50% by March 31, 2031.
• State Government Debt: The combined debt of state governments is suspected to be near 30%.​ The government has set this target to be 20% by 2023.
• Fiscal Deficit Targets: The government has set a fiscal deficit target of 4% of GDP for the fiscal year 2025-26, down from a revised 4.8% for the current year.
• Recent Fiscal Performance: As of January 2025, India’s fiscal deficit stood at ₹11.70 lakh crore, accounting for 5% of the full-year target.

Logic of 3% target:

The focus on Fiscal Deficit is mainly to ensure that the private sector has sufficient borrowing space.

Main Argument: There is a very limited amount of capital available for lending in the country, this is represented by the savings rate.

The total amount available for lending is therefore:

• Saving of household sector to GDP = 10%.
• Additionally, if the acceptable Capital Account Deficit = 1.5%; (representing external borrowing)

If the government and its agencies take the following share:

• 3% deficit for both states and Centre: 6% aggregate deficit.
• 5% for PSEs;

This would leave space of 4% for the private sector. But the bigger problem is the savings rate in recent times has reduced, leaving even lower levels of capital available for the private sector. How can India’s private sector grow with such little capital available for investment?

The latest household sector savings (2024) is just 5-6% of GDP and the foreign savings stand at 1-2%!

Limitations of FRBM

• Criticism of 3% Target: Limiting fiscal to 3% is arbitrary and more relevant to the West. The government never achieved its target.
• The FRBM Act does not force the government to make binding targets. There is no punishment for the government for not fulfilling these targets.
• The true test of Compliance is during a slowdown. But during COVID-19, the government went on a spending spree.
• Further, specifying a Fiscal deficit target of 3% wouldn’t be enough to achieve the debt target. The government has suspended its target of reaching a sustainable debt level of 60% already.

Advantages of the FRBM Act

FRBM Act helps in enforcing Fiscal Discipline.

• It helps in the Control of Inflation & Populism.
• It will keep the interest rates low.
• It allows the private sector to borrow and grow.
• It will help sustain healthy bond markets, otherwise, bond prices will drop.
• It will improve the credit rating of the government.
• It will protect banks from facing MTM losses on government securities.
• Binding spending rules: It helps the government adopt a counter-cyclical approach. Sustainable debt should be the guiding principle.

Way Forward: The 14th FC also recommended a mechanism ensuring compliance with fiscal targets & suggested an amendment in the existing FRBM act to form an independent council to assess fiscal policy implications of budget proposals & their consistency with the rule.

Our first target should be to eliminate the revenue deficit; 40% of the Estimated Fiscal deficit is a revenue deficit. (1.5% revenue deficit of 4.4% Fiscal deficit according to 2024-25 figures)

NK Singh Committee:

NK Singh Committee was a 5-membered panel announced in the Union Budget of 2016-17 to review the FRBM act and examine the following:

• Review the working of FRBM.
• Range: Examine the feasibility of having a fiscal deficit range rather than a point-based target deficit, giving flexibility to the government.
  1. Criticism: Point infuses fiscal discipline.
• Look at the prospects of aligning fiscal expansion/contraction with credit expansion/contraction.
  1. Review, if it is possible to build a provision for a counter-cyclical policy.
• Alternate arrangement:
  2. Fiscal deficit: The FRBM act gives a target of 2.5% for each state & centre each; 5% for the public and corporate sectors.
  3. Revenue deficit glide path: reaching 0.8% by 2022-23.
• Independent Fiscal Council: to oversee a rule-based adoption of fiscal policy.

NK Singh Committee Report:

Major Changes recommended in the FRBM Act to ensure responsible and higher growth. It was of the view that a new FRBM Act is critical to creating better conditions for coordination between monetary and fiscal policy and also usher in a low interest rate regime.”

It recommended the following:

Fiscal Council

It suggested the creation of a Fiscal Council: Its mandate will include the:

• Making multi-year fiscal projections,
• Preparing fiscal sustainability analysis,
• Independent assessment of the government’s fiscal performance and compliance with fiscal rules,
• Recommending suitable changes to fiscal strategy to ensure consistency of the annual financial statement and taking steps to improve the quality of fiscal data,
• Producing an annual fiscal strategy report which will be released publicly.

According to the IMF, about 50 countries around the world have established fiscal councils with varying degrees of success.

• Advantage: it will give an independent and expert assessment of the government’s fiscal stance, and thereby aid an informed debate in Parliament.
• Disadvantage: Another Bureaucratic machinery for the government’s performance assessment. Former RBI governor, D Subbarao suggest that existing mechanisms such as CAG must be strengthened to provide an expert analysis on Government’s fiscal prudence.

Counter-cyclical approach

There is also a suggestion that fiscal expansion or contraction should be aligned with credit contraction or expansion respectively in the economy. = Inverse relation.

• Why? If Banks can’t finance the economy, the Government would have to… Counter Cyclical.
• India is experiencing both, the Milton Effect (Friedman) and the Tobin effect: Both money expansion growth & Credit demand growth shrinking.

Reduction in the Targets

Note: Some of these targets are not relevant in the post-COVID scenario.

• Debt-to-GDP Target: Reduce general government debt (Centre + States) to 60% of GDP by 2023, with 40% for the Centre and 20% for States.
• Fiscal Deficit Target: Reduce the fiscal deficit to 3% of GDP by 2020, with a gradual reduction thereafter.
• Revenue Deficit Reduction: Achieve a zero revenue deficit over time to ensure borrowing is used for productive capital expenditure.
• Escape Clauses: Allow flexibility up to 0.5% of GDP in fiscal deficit targets during economic downturns, wars, or natural disasters.

It also called for improving budget transparency by including off-budget liabilities in fiscal deficit calculations.

Parliamentary Budget Office (PBO):

Comprised of independent-specialized staff(economists, finance experts etc.). It must serve all parliamentarians, and be accessible, transparent and understandable. Must be regularized.

Functions:

• Independent & objective economic forecasts.
• Baseline estimate surveys.
• Analysing Executive’s budget proposals.

Providing medium to long-term analysis.

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