Daily Answer Writing
24 February 2021

Q) The suspension of Fiscal Responsibility and Budget Management (FRBM) Act could spell dangers to the fiscal stability for India in the long run. Critically analyse.

Source: The Hindu Editorial: The excise duty-fiscal policy contradiction

GS 3: Indian Economy

Approach Answer:

 

Introduction: Fiscal responsibility and budget management(FRBM) Act, 2003 institutionalised fiscal discipline and  improve macroeconomic management by seeking to eliminate Revenue deficit and Bring down fiscal deficit to a manageable 3% of GDP. The government has recently decided to amend FRBM Act to achieve higher targeted Fiscal Deficit levels necessitated by the COVID crisis.

              

Fiscal stimulus is essential in the time of Crisis: 

               1. Growth: Debt-financed fiscal spending could well be a driver of growth.

               2. Improves standard of living: It can improve the standard of living of the entire population, without necessarily removing inequality.

               3. Stronger Multiplier effects: It has stronger multiplier effects during recessions than during booms. In an economic boom, state expenditure may crowd out private expenditure on account of a rise in the interest rate.

               4. Boosts economy: During recessions, private expenditure is low in any case, on account of a rise in precautionary savings and the grim state of long-term expectations. The government, however, is not affected by such psychological constraints. Its fiscal expenditure produces positive growth and this in turn can generate a feel good factor for the private sector over time, raise animal spirits, and improve the state of the economy.

 

But, in the long run Fiscal irresponsibility is a Problem:  Our Fiscal Responsibility and Budget Management (FRBM) Act, mandates to which the fiscal deficit must be capped under 3.5% or so.

               1. Debt traps: The idea underlying the prescription was that a fiscal deficit automatically transformed to government debt. Such debts along with their servicing liabilities have a tendency to magnify over the years, thereby imprisoning governments in debt traps, where present borrowings keep increasing to repay past borrowings and service charges.

               2. Reduces Credit worthiness/Future potential to borrow: This leaves little room for growth enhancing expenditure and reduces a government’s credit worthiness in the eyes of lenders.

               3. Problem of Inequality: The inequality, however, could well be benignant, for even though the rich will grow richer, the poor will escape out of poverty.]

               4. Reduces Government ability to introduce counter cyclical measures: Reducing spending  & raising tax during boom & vice versa can help the economy to cope with the hazardous impacts of burst and boom of the economic cycle.

               5. Fuelling Inflation: Which can in turn make the living difficult for the common man.

 

Conclusion: Although high debt levels have huge impacts on the risk to an economy, and breeding inequality. However, the crisis at hand makes it necessary to take such a one time measure. The Volume 1 of the Economic Survey 2020-21 considers the basics of fiscal policy. According to it, Debt-to-GDP ratio can be prevented from exploding if the rate of growth of GDP happens to be higher than the sovereign rate of interest.  India’s average interest rate and growth rate over the last 25 years have been 8.8% and 12.8% respectively. Hence according to the economic survey, debt financing of recession ought not to raise FRBM issues involving fear of future taxation to address past debts.

 

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