Fiscal Responsibility and Budget Management Act (FRBMA)

In this article we will discuss about Fiscal Responsibility and Budget Management Act (FRBMA):- 1. Introduction to FRBMA 2. Features of FRBMA 3. Measures. 

Introduction to FRBMA:

The Committee on Fiscal Responsibility Legislation was constituted on 17th January, 2000 to go into various aspects of the fiscal system and recommend a draft legislation on fiscal responsibility. This was followed by an announcement in the Budget 2000-2001 for a strong institutional mechanism embodied in a “Fiscal Responsibility Act” and to bring necessary legislative proposals to the House during the course of the year.

Accordingly, Fiscal Responsibility and Budget Management Bill 2000 was introduced in Lok Sabha in December 2000. Later on, the Fiscal Reforms Budget Management Act (FRBMA) was enacted on August 26, 2003 and the Act and its rules were notified to come into effect from July 5, 2004.

The main idea behind the introduction of this Bill was to put a cap on the limits of fiscal deficit every year and also on the mobilisation of resources through borrowing and multilateral debts from internal and external sources.

An institutional mechanism is proposed to be created under the proposed bill to regulate the system of capping of both limits of deficits and debts so that the country is not drowned under the debt trap and an effective, real and meaningful growth is assured.

Under the proposed system, an authority is to be created to regulate, control and administer the system of around fiscal discipline. Notwithstanding the fact that fiscal consolidation is one of the main elements of economic reforms adopted since July 1991, government finances continue to be a matter of serious concern.

This is evident from the movement of key fiscal indicators such as revenue deficit, fiscal deficit, primary deficit and primary revenue balance.

The persistence of large fiscal deficit and primary deficit have resulted in large debt. Moreover, revenue deficit became a permanent feature of the Indian fiscal system. Persistence of revenue deficit emanating from growing interest burden has resulted in a vicious circle of deficit and debt.

Such fiscal scenario implies severe fiscal stress and calls for bold measures either in terms of large mobilisation of resources or through expenditure management.

The Comptroller and Auditor General of India (CAG) has recently warned that the rising market borrowings of the government will lead to a “debt trap” and restrict the room for fiscal maneuver-ability.

CAG has recommended that fiscal responsibility in the matter of borrowings, use of funds, aberrant budgetary assumptions reported to Parliament and cases of significant deviations from fiscal rules, ought to be established through an Act.

Thus CAG argued that the centre should expedite the enactment of the proposed Fiscal Responsibility Act to address these issues.

The proposed law casts an obligation on the Government itself to strengthen the institutional framework for conduct of prudent and accountable fiscal policy and pave the way for promoting greater macro-economic stability. The following are some of the salient features of the proposed Fiscal Responsibility Bill.

Features of FRBMA:

Important features of the Act, inter alia, provide as under:

1. Laying before both Houses of Parliament, along with the annual Budget in each financial year the following statements of fiscal policy:

(a) Medium-term Fiscal Policy Statement;

(b) Fiscal Policy Strategy statement and;

(c) Macro-economic Framework Statement.

2. The Medium-term Fiscal^– Policy Statement shall set-forth a three-year rolling target for prescribed fiscal indicators with specification of underlying assumptions.

Besides, the Medium-term Fiscal Policy Statement shall include an assessment of sustainability relating to:

(i) The balance between revenue receipts and revenue expenditures; and

(ii) The use of capital receipts including market borrowings for generating productive assets.

3. The Fiscal Policy Strategy Statement shall, inter alia, contain:

(a) the policies of the Central Government for the ensuing financial year relating to taxation, expenditure, market borrowings and other liabilities, lending and investments, pricing of administered goods and services, securities and description of other activities, such as, underwriting and guarantees which have potential budgetary implications;

(b) The strategic priorities of the Central Government for the ensuing financial year in the fiscal area;

(c) The key fiscal measures and rationale for any major deviation in fiscal measures pertaining to taxation, subsidy, expenditure,, administered pricing and borrowings;

(d) An evaluation as to how the current policies of the Central Government are in conformity with the fiscal management principles set out in Fiscal Policy Strategy Statement and the objectives set out in the Medium-term Fiscal Policy Statement.

4. The Central Government shall take appropriate measures to eliminate the revenue deficit, bring down the fiscal deficit and build up adequate revenue surplus and in particular shall:

(a) Reduce revenue deficit by an amount equivalent to one-half per cent, or more of the estimated gross domestic product at the end of each financial year beginning on the 1st day of April, 2001;

(b) Reduce revenue deficit to nil within a period of five financial years beginning from the initial financial year on the 1st day of April, 2001 and ending on the 31st day of March 2006;

(c) Build up surplus amount of revenue and utilise such amount for discharging liabilities in excess assets;

(d) Reduce fiscal deficit by an amount equivalent to one-half per cent or more of the estimated gross domestic product at the end of each financial year beginning on the 1st day of April, 2001;

(e) Reduce fiscal deficit for a financial year to not more than two per cent of the estimated gross domestic product for that year, within a period of five financial years beginning from the initial financial year on the 1st day of April, 2001 and ending on the 31st day of March 2006;

(f) Not give guarantee for any amount exceeding one-half per cent of the estimated gross domestic product in any financial year; and

(g) Ensure within a period of ten financial years, beginning from the initial financial year on the 1st day of April, 2001, and ending on the 31st day of March, 2011, that the total liabilities (including external debt at current exchange rate) at the end of a financial year, do not exceed fifty per cent of the estimated gross domestic product for that year.

5. Prohibition of direct borrowings by the Central Government from the Reserve Bank of India after three years except by way of advances to meet temporary cash needs in certain circumstances.

6. Central Government to take suitable measures to ensure greater transparency in fiscal operations and to minimisation of, as far as practicable, secrecy in the preparation of the annual budget.

7. Quarterly review of the trends in receipts and expenditures in relation to the budget by the Finance Minister and placing the outcome of such reviews before both Houses of Parliament.

8. The Central Government to cut expenditure authorizations in a proportionate manner, while protecting the “charged” expenditure, whenever there is a shortfall of revenue or excess of expenditure over specified targets.

9. Finance Minister to make a statement in both Houses of Parliament explaining any deviation in meeting the obligations cast on the Central Government under this Act and the remedial measures the Central Government proposes to take.

10. Relaxation from deficit reduction targets to deal with unforeseen demands on the finances of the Central Government on account of national security or natural calamities of national dimension.

Thus the Fiscal Reforms and Budget Management Act (FRBMA) will provide a legal and institutional framework to bring down the fiscal deficit, contain the growth of public debt and stabilise debt as a proportion of GDP over the medium term. It binds future governments to a pre-specified path of fiscal consolidation. This covers only the finances of Central Government.

The matter regarding similar legislation at State level will be for State Governments to pursue. The Act proposes elimination of revenue deficit and progressive reduction of the fiscal deficit to not more than 2 per cent of GDP within a period of five financial years following the promulgation of the law.

Besides, the Bill contains provisions which will ensure flexibility in fiscal management under extraordinary circumstances like natural calamities and war. Under borrowing related principles, it is proposed to prohibit certain types of borrowing from the Reserve Bank of India.

The Act envisages that within a period of ten financial years, the total liabilities (including external debt at current exchange rate) do not exceed fifty per cent of the estimated gross domestic product.

Thus FRBMA is an important institutional expression for ensuring fiscal prudence and support for macro-economic balance. With the enactment of the FRBMA, the traditional practice of annual budgeting moved to a more meaningful medium-term fiscal planning framework.

According to rules so framed under the Act, revenue deficit is to be reduced by an amount equivalent to half per cent or more of the estimated GDP at the end of each financial year and is to be eliminated by March 31, 2009.

Fiscal deficit is to be reduced by an amount equivalent to 0.3 per cent or more of the estimated GDP at the end of each financial year and reduced to no more than three per cent of the estimated GDP by the financial year ending on March 31, 2009.

It is observed that the process of fiscal consolidation under FRBMA has been continuous and essentially an incremental one.

Measures of FRBMA:

Under FRBMA, some of the important fiscal measures that are now being implemented include:

(i) Rectifying aromatics like inverted duty structure;

(ii) Rationalizing excise duties with a movement towards a median CENVAT rate;

(iii) Revisiting the tax exemptions relying on voluntary tax compliance through tax payer facilitation;

(iv) Introduction of state-level VAT for achieving a non-cascading, self-enforcing, and harmonized Commodity taxation regime;

(v) Increasing productivity of expenditure through an outcome budget framework, which seeks to translate outlays into betters outcomes through monitor-able performance indicators; and

(vi) Innovative financing mechanism like creation of special Purpose vehicle (SPV) for infrastructure projects. As per FRBMA provision, states have also joined the process of fiscal consolidation in line with the Twelfth Finance Commission’s (TFC) recommendations and are now complementing seriously the efforts of the Central Government.

It is observed that the progress in fiscal consolidation has also been satisfactory in the post-FRBM period. The fiscal deficit of the Centre as a proportion of GDP has declined from 6.2 per cent in 2001-02 to 3.8 per cent in 2006-07. While the previous efforts at fiscal consolidation in the pre-FRBM era was not consistently successful but the mandated FRBMA mechanism has proved to be more effective.

As a result of FRBMA, the revenue deficit and fiscal deficit has been declining consistently in the post-FRBM period. Gradual decline in revenue deficit together with the reduction in fiscal deficit resulted in a decline in the proportion of revenue deficit to fiscal deficit by 22.7 percentage points in three years (2003-06).

The proportion of borrowed funds applied to assets creation, correspondingly increased to 43 per cent in 2006-07.

The fiscal situation of the states also improved considerably which in fact was even better as compared to that of Central Government. Fiscal deficit of states as a proportion of GDP declined by 1.9 percentages points in the post FRBMA period, i.e., from 4.5 per cent in 2003-04 to 2.6 per cent in 2006-07.

The revenue deficit is budgeted to get eliminated by 2006-07, two years ahead of schedule. A strong incentive based restructuring scheme of fiscal transfers to serve the objectives of equity and efficiency by embedding in a framework of fiscal consolidation proposed by TFC seems to have succeeded.