FRBM Act

The Fiscal Responsibility and Budget Management (FRBM) Act came into being in 2003 to maintain fiscal discipline and promote transparency in India's government spending. It aimed to address issues like high fiscal deficits, growing debt burdens, and lack of transparency. The Act mandated limits on fiscal deficit and debt levels to promote responsible fiscal management. On July 2, 2004, the government enacted the Fiscal Responsibility and Budget Management (FRBM) Act, along with its associated Rules, which came into effect on July 5, 2004. The Act aims to eliminate revenue deficit by March 31, 2008 and outlines annual reduction targets for deficits, government borrowing, and debt. Recent amendments set a fiscal deficit target of 3.1% by March 2023.

However, the Act faced challenges due to arbitrary targets, inflexibility during economic crises, and lack of enforcement mechanisms. Recommendations from committees like the N.K. Singh committee emphasized the need for flexible targets and enhanced oversight. The FRBM Act needs to evolve to adapt to changing economic realities and incorporate reforms for better fiscal management.

During the 1990s and 2000s, India encountered notable economic difficulties characterized by substantial borrowing, fiscal deficits, revenue deficits, and a rising debt-to-GDP ratio. This situation raised concerns about the sustainability of the country's economic health. The government's heavy borrowing burdened the economy, with a large portion of funds allocated to servicing previous debts rather than productive investments, leading to a precarious financial situation. Acknowledging the immediate requirement for fiscal discipline and responsible handling of public finances, the Indian government proposed the Fiscal Responsibility and Budget Management (FRBM) Bill in 2000.

The FRBM Act, passed in 2003, aimed to instill fiscal discipline, streamline expenditure and revenue management, enhance macroeconomic stability, and foster transparency in fiscal operations. It came into effect on July 5, 2004. Effective management of public debt is crucial to prevent future generations from being burdened with excessive debt and ensuring fiscal sustainability.

The FRBM Act was crafted with several core objectives:

1. Limit Government Spending: Encourage fiscal discipline by placing limits on government spending and borrowing.
2. Reduce Deficit: Progressive reduction of both revenue and fiscal deficits to more sustainable levels, contributing to macroeconomic stability and inflation control.
3. Transparency: Improving fiscal transparency and accountability by establishing clear targets for various indicators and requiring timely reporting of fiscal performance.
4. Rationalise Spending: Maximizing resource allocation by cutting unnecessary spending and giving priority to crucial sectors of economy.
5. Encourage Investment: Boosting private investors confidence by showing the government's dedication to fiscal discipline, thus encouraging investment in the economy.
6. Maintaining macroeconomic stability: by controlling inflation, stabilizing rupee, and preventing economic imbalances.

The FRBM Act introduced key provisions to guide fiscal management:

1. Fiscal Targets & Limits on Debt: The FRBM Act sets clear fiscal goals to be met within a specified period, with a focus on lowering fiscal and revenue deficits to pre-set thresholds.
   • The target for revenue deficit elimination was set for March 31, 2009, with a minimum annual reduction requirement of 0.5% of GDP.
   • The goal of the fiscal deficit target was to bring it down to 3% of GDP by March 31st, 2009, with a yearly reduction target of at least 0.3% of GDP.
   • Starting from the financial year 2004-05, the Central Government was instructed not to provide incremental guarantees exceeding 0.5% of GDP.
   • The purchase of government bonds by the RBI was stopped from April 1, 2006, no more allowing government to borrow directly from the RBI thereby stopping monetisation of deficit.

   Renewed Targets: These targets have been revised by various amendments, the current ones are below:-

   • By March 31st, 2021, the government needs to limit the fiscal deficit to 3% of the GDP.
   • By the financial year 2024-25, the central government is mandated to cap its debt at 40% of the GDP.
2. Three Policy Statements: The central government is required to present three statements – the Medium-term Fiscal Policy Statement, the Fiscal Policy Strategy Statement, and the Macroeconomic Framework Statement – along with the Annual Financial Statement (budget) to both Houses of Parliament. Additionally, quarterly reviews of expenditure and receipt trends in relation to the budget must be submitted to Parliament.
   • The Medium-term Fiscal Policy Statement establishes targets for fiscal indicators over a three-year period and assesses whether revenue expenses can be sustained by revenue receipts, as well as the effective utilization of capital receipts.
   • The Fiscal Policy Strategy Statement outlines the government's fiscal priorities, evaluates current policies, and provides rationale for any deviations in significant fiscal measures.
   • The Macroeconomic Framework Statement evaluates the economy's prospects, including GDP growth, central government fiscal balance, and external balance.
3. Deficit Reduction Goals: Progressive reduction of fiscal and revenue deficits over time is a key objective of the act, with targets set as a percentage of GDP.
4. Revenue Deficit must be zero: Establishing a goal of eliminating revenue deficit completely demonstrates the government's dedication to generating adequate revenue to cover all its expenditures, except for interest payments.
5. Contingent Liabilities and Off-Budget Transactions: Disclosure of contingent liabilities and off-budget transactions enhances transparency in fiscal reporting, ensuring comprehensive disclosure of government financial obligations.
6. Exemptions and Escape Clauses: The FRBM Act includes clauses that allow for exceptions and escape routes during extraordinary situations, such as national security and calamity emergencies, also when the gdp growth rate or output of the economy is going down rapidly (recession period), providing some flexibility in management of fiscal targets.

FRBM Act & States: Although the Act pertains to the central government, states have also enacted fiscal responsibility legislations, broadening the government's rule-based fiscal reform program. However the target setting in FRBM Act is for both states and centre’s debt combined.

• Article 293 of the Indian Constitution provides that States have the authority to borrow money within India, secured by their Consolidated Fund, within limits set by their respective legislatures. They also have the power to provide guarantees within these limits. However, they cannot borrow without the consent of the Government of India if any previous loans or guarantees from the Government of India are outstanding.

In May 2016, the Indian government formed a committee led by N.K. Singh to assess the Fiscal Responsibility and Budget Management (FRBM) Act.

• Revise Targets: The committee found that the fiscal deficit targets in the FRBM Act were too strict, given the requirement for flexibility in adapting to changing economic circumstances. It proposed revision of these:
  1. The committee proposed aiming for a fiscal deficit of 3% of the Gross Domestic Product (GDP) until March 31, 2020. After that, it suggested reducing the fiscal deficit to 2.8% in the fiscal year 2020-21, followed by a further decrease to 2.5% by the fiscal year 2023. This meant an annual reduction target of 0.3% of GDP.
  2. The committee proposed targeting a debt-to-GDP ratio of 60%, with 40% allocated for the central government and 20% for the states.
  3. The committee suggested lowering the revenue deficit to 0.8% of GDP by March 31, 2023, with a yearly reduction target of 0.5% of GDP.
• Targeting Debt: Until now, the focus of the act has mainly been on targeting fiscal deficit. However, the Committee proposed shifting the primary target for fiscal policy to debt. They recommended setting a target debt-to-GDP ratio of 60%, with 40% allocated to the central government and 20% for all states combined.
• Escape Clause: It grants the central government leeway to adjust fiscal deficit targets under exceptional circumstances, upon advice from the Fiscal Council. However the deviation must not exceed more that 0.5% of the GDP in that year. These exceptions include:
  1. national security concerns, war, natural disasters, or agricultural crises affecting output and incomes,
  2. structural reforms in the economy with fiscal implications, or
  3. a decline in real output growth of at least 3% compared to the previous four quarters' average.

In the year 2012 and 2015, notable changes were introduced to the FRBM Act, resulting in an extension of target realization years.

• Introduction of Effective Revenue Deficit (E.R.D): Effective Revenue Deficit (E.R.D) is the difference between revenue expenditure and revenue receipts, excluding grants for creation of capital assets.
• Inclusion of Medium-Term Expenditure Framework Statement
• Revised Targets:
  • The fiscal deficit target for 2022-23 stands at 6.4% of the GDP.
  • Similarly, the revenue deficit for 2022-23 is 3.8% of the GDP.
  • Revised estimates suggest that the fiscal deficit is likely to slightly exceed the budgeted estimate, reaching 6.9%, while the revenue deficit is anticipated to decrease to 4.7%.

• The Finance Minister said that the projected fiscal deficit for the fiscal year 2024-25 stands at 5.1% of the GDP.
• The government maintains its dedication to fiscal consolidation, aiming to bring down the fiscal deficit to under 4.5% by the fiscal year 2025-26, as declared in the Budget Speech for 2021-22.

Maintaining fiscal discipline is paramount to ensure economic stability and prevent the accumulation of unsustainable debts. Without prudent fiscal management, a country risks falling into a debt trap, jeopardizing its long-term economic viability.

The Fiscal Responsibility and Budget Management (FRBM) Act, aimed at ensuring fiscal discipline and transparency, has played a pivotal role in India's fiscal governance. By setting specific targets and guidelines, it promotes responsible fiscal management, aiming to reduce fiscal deficits and manage government debt. It establishes an institutional framework committing the government to a prudent fiscal policy aimed at achieving sustained growth and inter-generational equity.

Looking ahead, there should be a focus on sustainable fiscal policies that balance the need for growth with the imperative of fiscal discipline. This includes exploring innovative revenue generation measures, optimizing expenditure allocation, and enhancing fiscal transparency and accountability. Additionally, there is a need to foster greater public engagement in the fiscal policymaking process through consultations and transparency initiatives to enhance accountability and legitimacy.