Fiscal Responsibility and Budget Management FRBM Act 2003

Concerned over the worsening of fiscal situation, in 2000, the Government of India had set up a committee to recommend draft legislation for fiscal responsibility. Based on the recommendations of the Committee, Government of India introduced the Fiscal Responsibility and Budget Management (FRBM) Bill in December 2000. In this Bill numerical targets for various fiscal indicators were specified. The Bill was referred to the Parliamentary Standing Committee on Finance. The Standing Committee recommended that the numerical targets proposed in the Bill should be incorporated in the rules to be framed under the Act. Taking into account the recommendations of the Standing Committee, a revised Bill was introduced in April 2003. The Bill was passed in Lok Sabha in May 2003 and in Rajya Sabha in August 2003. After receiving the assent of the President, it became an Act in August 2003. The FRBM Act 2003 was further amended.

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The FRBM Bill / Act provides rules for fiscal responsibility of the Central Government. The FRBM Act 2003 (as amended) became effective from July 5, 2004. Under this Act, Rules are framed relating to fiscal responsibility of the Central Government, which came into force on 5th July 2004.

Objectives of FRBM Act 2003 ↓

The main objectives of FRBM Bill / Act are :-

1. To reduce fiscal deficit
2. To adopt prudent debt management.
3. To generate revenue surplus.

Features of FRBM Act 2003 ↓

1. Revenue Deficit

The first important feature of Amended FRBM bill 2000 or FRBM Act 2003 is that the central government should take certain specific measures related with reduction of revenue deficit.

Measures relating to reduction of revenue deficits are:-

1. The government should reduce revenue deficit by an amount equivalent to 0.5 percent or more of the GDP at the end of each financial year, beginning with 2004-2005.
2. The revenue deficit should be reduced to zero within a period of five years ending on March 31, 2009.
3. Once revenue deficit becomes zero the central government should build up surplus amount of revenue which it may utilised for discharging liabilities in excess of assets.

2. Fiscal Deficit

The second important feature of Amended FRBM bill 2000 or FRBM Act 2003 is that the central government should take certain specific measures related with reduction of fiscal deficit.

Measures relating to reduction of fiscal deficits are:-

1. The government should reduce Gross fiscal deficit by an amount equivalent to 3.3% or more of the GDP at the end of each financial year, beginning with 2004-2005.
2. The central government should reduce Gross Fiscal deficit to an amount equivalent to 2% of GDP upto March 31 2006.

3. Exceptional Grounds

The third important feature of Amended FRBM bill 2000 or FRBM Act 2003 is that it clearly stated that the revenue deficit and fiscal deficit of the government may exceed the targets specified in the rules only on the grounds of national security or national calamity faced by the country.

4. Public Debt

The fourth important feature of Amended FRBM bill 2000 or FRBM Act 2003 is that the central government should ensure that the total liabilities (including external debt at current exchange rate) should not exceed 9% of GDP for the financial year 2004-2005. There should be progressive reduction of this limit by atleast one percentage point of GDP in each subsequent year.

5. Borrowing from the RBI

The fifth important feature of Amended FRBM bill 2000 or FRBM Act 2003 is related with borrowings done by central government from R.B.I. The Amended FRBM bill 2000 or FRBM Act 2003 clearly states that the central government shall not normally borrow from the R.B.I. However the central government may borrow from R.B.I. by way of advances to meet temporary excess of cash payments over the cash receipts during any financial year in accordance with the agreements which may entered into by the government with the R.B.I.

6. Fiscal Transparency

The sixth important feature of Amended FRBM bill 2000 or FRBM Act 2003 is related with fiscal transparency. The Amended FRBM bill 2000 or FRBM Act 2003 clearly stated two important measures to ensure greater transparency in fiscal operations of the government.

These two important features are as follows :-

1. The central government should minimize as far as possible secrecy in preparation of annual budget.
2. The central government at the time of presentation of the annual budget shall disclose the significant changes in accounting standards, policies and practices likely to affect the computation of fiscal indicators.

7. Limit On Guarantees

The seventh important feature of Amended FRBM bill 2000 or FRBM Act 2003 is that it restricts the guarantees given by the central government to 0.5% of GDP in any financial year beginning with 2004-2005.

8. Medium term fiscal policy statement

The eighth important feature of amended FRBM bill 2000 or FRBM Act 2003 is that the central government should present medium term fiscal policy statement in both houses of parliament along with annual financial statement. The medium term fiscal policy statement should project specifically for important fiscal indicators.

These fiscal indicators are as follows :-

1. Revenue deficit as percentage of GDP.
2. Fiscal deficit as percentage of GDP.
3. Tax revenue as percentage of GDP.
4. Total outstanding liabilities as percentage of GDP.

9. Compliance of rules

Finally the ninth important feature of Amended FRBM bill 2000 or FRBM Act 2003 is related with measures to enforce compliance of rules.

These measures are as follows :-

1. The FRBM bill clearly states that the Finance Minister shall review every quarter, the trends in receipts and expenditure in relation with the budget and place it before both houses of parliament the outcome of such reviews.
2. The finance minister shall also make statement in both houses of parliament if there is any deviations in meeting the obligations of the central government.
3. If deviations are substantial then the Finance Minister will declare the remedial measures which the central government proposes to take in future period of time.
4. The rules mandate the central government to take appropriate corrective action in case of revenue & fiscal deficit exceeding 45% of the budget estimates or total non-debt receipts falling short of 40% of the budget estimates at the end of first half of the financial year.

10. Task force on implementation of FRBM Act

Following the enactment of FRBM Act, Government constituted a Task Force headed by Dr. Vijay Kelkar for drawing up the medium term framework for fiscal policies to achieve the FRBM targets.

The task force proposed the following measures :-

1. Widening the tax base through removal of exemptions.
2. An All-India goods and service-tax (GST) on the basis of a "grand bargain" with States, whereby States will have the concurrent powers to tax service, subject to certain principles that will help foster a national common market.
3. Income tax exemption limit to be increased to Rs.1,00,000.
4. A two-tire rate structure of 20 percent tax for income of Rs. 1,00,000 to Rs. 4,00,000 and 30% for income above Rs. 4,00,000 for individuals and elimination of standard deduction available to the salaried taxpayer.
5. A reduction in the corporate income tax to 30% for domestic companies and the reduction in depreciation rates from 25 to 15%.
6. A 3-tier custom duty rates of 5, 8 and 10% to bring down tariffs to ASEAN levels.
7. Allocation of greater portion of expenditure to legitimate public goods by revisiting the classification of expenditure.
8. Empowering panchayats / local bodies through reserve transfer.

The task force stated that under the reforms measures recommended by it, tax GDP ratio of the central government should be raised from 9.2% in 2003 to 13.2% of GDP in 2008-09. A revenue surplus of 0.2% of GDP is estimated to emerge in 2008-09. Fiscal deficit estimated to fall from 4.8% of GDP in 2003-04 to 2.8% of GDP in 2008-09.

The above features of Amended FRBM bill 2000 or Fiscal Responsibility and Budget Management Act 2003 clearly points out that the government intends to create a strong institutional mechanism to restore fiscal discipline at the level of the central government. Similarly the government wants to introduce greater transparency in fiscal operations of the central government.

Criticism / Limitations of FRBM Act 2003 ↓

Though the Fiscal Responsibility and Budget Management Act 2003 or Amended FRBM bill 2000 is a credible effort by the government to fix responsibility on the government to reduce fiscal deficit and bring transparency in fiscal operations of the government it has certain limitations.

These limitations of Amended FRBM Bill 2000 or FRBM Act pointed out by various economists are as follows :-

1. Target regarding GFD very stringent

The Bill stipulates that by March 31, 2006, the Gross Fiscal Deficit (GFD) as a proportion of GDP must be 2%. This, of course, means that the government can borrow from the economy only to the extent of 2% of GDP, whatever be the level of savings. Given the present need of government borrowings, 2% limit is very low.

The increase in public investment helps to increase the level of effective demand and increases private investment in the economy. According to Dr. Raja Chelliah the ratio of Gross Fiscal Deficit (GFD) to GDP should be 4% to 5% of GDP as public investment on infrastructure sector is essential to boost economic growth.

2. Neglect of equity and growth

According to critics the Amended FRBM Bill 2000 or FRBM Act 2003 is heavily loaded against investment in both human development and infrastructure sector. One of the major ommission of amended FRBM Bill 2000 or FRBM Act 2003 was complete absence of any target for time bound minimum improvement in areas of power generation, transport, etc. which is very important both from the point of equity and higher economic growth.

3. Non-Coverage of State Governments

The provisions of the bill impose restrictions on only the central government but state governments are out of its scope. But, deficits of state governments are as much or even a greater problem. For instance, the State of Maharashtra has already crossed the deficit of Rs. 1 lakh crore as on December 2004 (the second State after Up to cross deficit of Rs. 1 lakh crore). Therefore, there is a need for fiscal responsibility legislation for the State Governments as well.

4. Neglect of Development Needs

Today, the levels of capital expenditures by the government are miserably low in India. These capital expenditures increase the efficiency and productivity of private investment and thus contribute to the development process in the country. If Revenue Deficit is to be reduced to zero and GFD to be 2% of GDP as per the requirement of FRBM Bill, it is the capital expenditure which will be sacrificed and thus will hinder further development of the country.

5. Need to Increase Revenue

Revenue deficits are determined by the interplay of expenditure and revenues, both tax and non-tax. Too often, attention gets focused only on the expenditure side of the identity to the neglect of the revenue side. Increasing non-tax revenue requires that public sector services be appropriately priced, which may be difficult as the present society has got used to the subsidised education, health, food items, etc.

6. Neglect of Social Sector

The FRBM bill does not mention anything relating to social sector development. However, investment in social sector such as health, education, etc is very vital for the economic development of the nation.

7. Problem of Subsidies

The government may be able to reduce revenue deficit by reducing subsidies. However, it is quite likely that the government will be under severe pressure to continue the subsidies. It means the expenditure on the productive areas may be reduced due to subsidies.

8. Stable Growth Deficit

Chelliah points out that given the household financial savings in India, the overall fiscal deficit termed as stable growth deficit of the government sector as a whole should be pegged at 6% of GDP with revenue deficit being gradually phased out. Thus, the target of 2% of fiscal deficit GDP ratio stated in FRBM bill is not desirable from the point of view of productive investment according to Chelliah.

9. False Assumptions

The FRBM Bill is based on the following assumptions :-

1. Lower fiscal deficit lead to higher growth.
2. Larger fiscal deficit lead to higher inflation
3. Larger fiscal deficit increase external vulnerability of the economy.

These assumptions have been rejected by C.P. Chandrashekhar and Jayanti Ghosh who have given the following arguments :-

1. If the deficit is in the form of capital expenditure it would contribute to future growth.
2. Fiscal deficit is not only the cause for higher inflation. During the late 1990s the rate of inflation has fallen even when the fiscal deficit was as high as 5.5% of GDP.
3. Higher fiscal deficit need not necessarily cause external crisis. The external vulnerability depends more on capital and trade account convertibility. In India we have managed to build large foreign exchange reserves, though fiscal deficit has not come down.

Conclusion on FRBM Act 2003 ↓

The Amended FRBM Bill 2000 or FRBM Act 2003 despite above criticism can play a very important role in controlling fiscal deficit and in bringing transparency in fiscal operation of the government if it is implemented effectively in letter and spirit by the concerned government.