Context: The Fiscal Responsibility and Budget Management (FRBM) Act, 2003 was enacted to ensure macro-economic stability and inter-generational equity. The Act's rigid framework has been increasingly criticised for its limitations, especially during the times of economic crises.
Relevance of the Topic: Prelims: Key features of FRBM Act, 2003. Mains: FRBM Act- Limitations, Reforms.
Fiscal Responsibility and Budget Management (FRBM) Act, 2003:
- The Act aims to ensure a balance between government revenue and government expenditure. It set deficit targets for the Union and States to control their deficits.
- Objectives:
- Ensuring fiscal discipline.
- Efficient management of expenditure, revenue and debt.
- Promoting macroeconomic stability.
- Better coordination between fiscal and monetary policy.
- Increasing transparency in the fiscal operation of the Government.
Salient Features of Fiscal Responsibility and Budget Management Act, 2003
- Section 4(1) of the FRBM Act provides that the Central Government shall:
- Take measures to limit the fiscal deficit up to 3% of GDP.
- Ensure that by the end of Financial Year 2024-25:
- General Government debt does not exceed 60% of GDP.
- Central Government debt does not exceed 40% of GDP.
- Not give additional guarantees with respect to any loan on security of the Consolidated Fund of India in excess of one-half per cent of GDP, in any Financial Year.
- Ensure that the fiscal targets are not exceeded after stipulated target dates.
- Under Section 5 of the Act, except for certain circumstances, the Act does not allow the Central Government to borrow from the Reserve Bank of India (RBI).
FRBM Review Committee headed by NK Singh
The government believed the targets set by the FRBM Act were too rigid. In 2016, the government set up a committee under NK Singh to review the FRBM Act. Targets set by NK Singh Committee:
- Debt to GDP ratio:
- The Committee suggested using debt as the primary target for fiscal policy.
- It advocated for a Debt to GDP ratio of 60% with a 40% limit for the centre and a 20% limit for the states.
- Revenue Deficit Target:
- It should be reduced to 0.8% of GDP by March 31, 2023. The minimum annual reduction target was 0.5% of GDP.
- Fiscal Deficit Target:
- The government should target a fiscal deficit of 3 percent of the GDP in the years up to March 31, 2020, cut it to 2.8 per cent in 2020-21.
- It should be reduced to 2.5% of GDP by March 31, 2023. The minimum annual reduction target was 0.3% of GDP.
FRBM Act – Escape Clause
- The FRBM Act was amended in 2018, adding specific details that were given in Section 4(2).
- If the escape clause is triggered, RBI is then allowed to participate directly in the primary auction of government bonds, thus formalising deficit financing.
- Deficit financing refers to the method of financing the budget deficits — such as issuing bonds or printing more money.
- FRBM Act Section 4(2), provides for a trigger mechanism to escape deficit control–related clauses in the act and the Government can over cross the targets in the following situations:
- National Security / Act of War
- National Calamity
- If agriculture output and farm incomes collapse
- Fall in real output/GDP growth rate beyond x%
- Structural reforms in the economy with unanticipated fiscal implications.
- During the above trigger conditions:
- The government may over cross/deviate from the fiscal deficit target by up to 0.5% of GDP, as recommended by NK Singh’s FRBM Review Committee.
- Individual State Governments may also do similar (E.g., overcross by 0.5% of GSDP), after amending the state FRBM Act accordingly.
- The Finance Minister cited structural reform to escape the FRBM targets for 2019-20 and 2020-21.
- In Budget-2021, FRBM was amended to provide a fiscal deficit target of 4.5% by 2025-26, as recommended by the 15th FC.
Documents Mandated by FRBM Act
- Macroeconomic Framework Statement: This statement provides an overview of the economy, including GDP growth, inflation, receipts and expenditure.
- Medium-Term Fiscal Policy Statement: This statement sets out the government’s fiscal policy goals for the medium term.
- Fiscal Policy Strategy Statement: This statement explains how the government plans for fiscal policy goals.
- Medium-Term Expenditure Framework: This framework sets out the government’s spending plans for the medium term.
2024-25: Budget Estimates vs. Revised Estimates
- Revenue Receipts: There is a decline in revenue receipts, which could increase the revenue deficit by 0.8% of GDP. This would mean the government is saving less, which negatively impacts economic growth.
- Capital Expenditure: Capital expenditure is also expected to decline by 1.1% of GDP. This will slow down economic growth further.
- Impact on Growth: The combined effect of the decline in revenue receipts, non-debt capital receipts, and capital expenditure has already contributed to a decrease in real economic growth from 8.2% in 2023-24 to 6.4% in 2024-25.
- Fiscal Deficit: The decline in revenue receipts and capital expenditure, along with a drop in non-debt capital receipts, is expected to slightly increase the fiscal deficit-to-GDP ratio.
Way Forward
2025-26 Budget should aim to amend the FRBM targets by:
- Eliminating the revenue deficit:
- The government should aim to eliminate the revenue deficit by 2027-28. This will help increase savings and support economic growth.
- Reducing the fiscal deficit to 3% of GDP:
- The fiscal deficit should be reduced to 3% of GDP within the next three years.
- Reducing the debt-to-GDP ratio to 50% over the next three years.
- The current rule of a 40% debt-to-GDP ratio is strict.
- The government should consider reducing it to 50% from the current 56.8% (estimated for 2024-25) over the next three years.
- Introducing a rule to ensure that capital expenditure stays at 3% of GDP.
- The government often plans high capital expenditure in the budget but later reduces it, which distorts fiscal management. To fix this, the government should set a clear target for capital expenditure at 3% of GDP.