One of the most distinguishing features of India’s emergence as a preferred investment destination in recent years has been the strength of its policy and institutional frameworks.
- Decisions such as e-auctioning of natural resources, a rule-based framework for Indian monetary policy, insolvency and bankruptcy code, the goods and services tax, amongst others, have all aimed at enhancing the credibility of policy and institutional frameworks.
- While these measures are encouraging, going forward it will become increasingly critical to codify fiscal rules so as to make it insulated from populist manoeuvres.
- In this context, the framework regarding fiscal responsibility and discipline as outlined by the previous version of the Fiscal Responsibility and Budget Management (FRBM) Act needs to get urgently revived and fine-tuned taking into account the ongoing changes in the global and domestic economic and financial order.
- While there is little doubt that in a developing economy such as India the government needs to spearhead a prominent role in funding growth, an institutional mechanism that imposes rule-based parameters on government’s spending and deficit significantly enhances its credibility.
History of FRBM Act
- The FRBM Act was first introduced in India in December 2000 to rein in burgeoning government deficits both at the Centre and in the States.
- Enacted in 2003, the FRBM Act institutionalised fiscal discipline, by seeking to eliminate revenue deficit and to bring down fiscal deficit to a manageable 3 per cent of GDP by FY08 from 5.7 per cent of GDP in FY03.
- However, during the international financial crisis of 2008, as government spending became critical to revive growth amid sharp decline in private investments, the deadline for attainment of the target was pushed forward and later suspended.
Present scenario
In the 2016 Budget speech, in a bid to reinforce the commitment to fiscal consolidation, the Hon’ble Finance Minister instituted a committee to review the contours of the FRBM Act in the light of current domestic and global dynamics. With the committee expected to submit its report by the end of the current month, the following issues need to be reflected upon.
- Range-based target Vs Point-based target
- Amid government’s increased role in reviving growth, debate has emanated on whether it would be appropriate to impart flexibility to the government by adopting a range-based target as opposed to a point-based target for fiscal deficit.
- A point target that infuses fiscal discipline, limits the room for government manoeuvres and provides an unambiguous signal to the bond markets is superior to a range target.
- A focused policy communication, complementing the objectives of monetary policy, is likely to result in a ratings upgrade for the Indian sovereign, which will eventually percolate down to lower cost of borrowing for the private sector, which is important for new capital and investment formation.
- Appropriate fiscal deficit target
- Macro underpinning of sustainable fiscal deficit comes from the supply of funds in the economy.
- The fiscal space for the government is expected to be created after meeting the demand for excess funds from the corporate sector in order to ensure there is adequate crowding-in of private investments.
- Given that the total supply of funds through household financial savings and sustainable capital flows are estimated at 10-12 per cent of GDP and demand for excess funds from the corporate sector is estimated at 4-6 per cent of GDP, a consolidated fiscal space of around 6 per cent of GDP exists for States and the Centre put together.
- This implies a 3 per cent headline fiscal deficit target for the Centre and States each. Hence an appropriate fiscal deficit target should be set.
- Need for guiding principle
- A binding spending rule along with a medium-term debt range that takes into account the specific institutional setting in each country would help to enhance the policy credibility and facilitate effective monitoring that would ensure stability, fairness and efficiency.
- Moreover, effective rule-based policy would help the governments adopt a countercyclical approach and limit the scope for creative accounting.
- Regarding a debt sustainability rule, a ceiling on government debt at 60 per cent of GDP can get adopted over the next three years (67.2 per cent of GDP currently) with indicators of sustainable debt serving as guiding principles, in line with the Maastricht Treaty guidelines.
- And expenditure rules that focus on enhancing the quality of spending and improve accountability are preferred in many countries. In case of India, a preference for capital spending (in both agriculture and manufacturing) should receive budgetary enunciation.
- Independent constitutional body
- The revised FRBM framework can consider setting up an independent reviewer, a Fiscal Council, to oversee the adoption of rule-based fiscal policy and also recommend future course of public policy advocacy.
- A well-designed fiscal council with strict operational independence will boost fiscal accountability and transparency and will further add to the sovereign’s credence and rating potential.
Conclusion
The adoption of version 2.0 of the FRBM framework will enhance the efficacy of India’s fiscal policy and significantly reduce the twin-deficit vulnerability.
At a juncture where most developed economies are struggling with their government’s balance sheet to support the economy, a rule-based system with room for independent advisory and oversight can transform India’s fiscal architecture and create enablers for germination of green field investment appetite.
Category: Mains | GS – III| Economics
Source: The Hindu
