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A new fiscal framework for India

A new fiscal framework for India

By Meghaa Gangahar

The Fiscal Responsibility and Budget Management (FRBM) Review Committee’s report recommends making fundamental changes to India’s fiscal policy. The controversial proposal targets debt and the deficit in new ways. This fresh framework could be the solution that the Indian economy needs at this juncture.

The committee’s goals

The committee recommended bringing the fiscal deficit ratio down to 2.5 percent of the GDP by Fiscal Year 2023 while maintaining a target of three percent between Fiscal Years 2018-20. Meanwhile, the revenue deficit is slated to come down to 0.8 percent during this period. This hints at the acceptance of the fact that the revenue deficit cannot be nil. In other words, the account cannot be in surplus after such a short period of time.

India remains one of the most indebted countries globally, with a current debt-to-GDP ratio of about 70 percent. The committee has made recommendations to help tackle this situation and push down the figure. The target for the debt-to-GDP ratio is set at 60 percent. The Centre’s ratio is expected to fall from 49 percent to 40 percent, while the states move from 21 percent to 20 percent.

A novel fiscal framework

In its report, the committee proposed establishing a new fiscal framework for India. The new framework is designed to target debt and the debt-to-GDP ratio, in addition to the previously targeted fiscal deficit. This was done in order to align with solvency considerations, follow best international practices, and avoid the threat of a debt trap.

If the government wants to meet the recommended targets, The FRBM Act will need to be replaced by a more suitable framework for fiscal governance. To this end, the committee recommended setting up an autonomous fiscal council under the Ministry of Finance. A new Debt Management and Fiscal Responsibility Act (‘Debt Act’) would guide the council’s practices. This Debt Act would replace the FRBM Act. The fiscal council would be monitoring the government’s fiscal announcements for any given year, providing independent forecasts and analysis of key macro variables. The council should advise the finance ministry on triggering the escape clauses placed in the framework.

According to Moody’s, “an effective implementation of fiscal discipline within a framework consistent with the FRBM’s recommendation and supported by the set-up of a fiscal council would point to a lower debt burden over time and would support India’s credit profile.” India has been trying to increase its credit rating by introducing a variety of structural reforms. These include the Goods and Service Tax Bill, labour reforms, the Bankruptcy Act, and more. A higher credit rating would make the Indian market more lucrative and attractive to investors.

An escape route for the government

Among the recommendations of the committee is the suggestion of an ‘escape clause’ that could be invoked by the government in dire situations of economic stress. The clause states that under such circumstances, the government can exceed the stipulated deficit for the particular year by up to 0.5 percentage points. On the other hand, a buoyancy clause ensures that if the growth is consistently stronger than expected, then the deficit must fall by over 0.5 percentage points. This is to take advantage of the boost in growth and strengthen India’s financial position.

The escape clause can be invoked in the case of overriding consideration of national security, acts of war, national calamities, and a collapse of agriculture severely affecting farm output and incomes. Additionally, a decline of at least 3 percentage points below the mean for four consecutive quarters would permit employing the clause. The clause can also be invoked if “far-reaching structural reforms” are introduced in the economy which have the potential for major fiscal implications. Interestingly, the introduction of the GST (Goods and Services Tax) qualifies as such a structural reform. However, the clause has not been invoked for the current fiscal year yet.

Cause for dissent? 

The FRBM Review Committee headed by former Revenue Secretary NK Singh included Sumit Bose, Rathin Roy, Reserve Bank of India Governor Urjit Patel, and Chief Economic Adviser Arvind Subramanian – who also submitted a note of dissent along with the report.

In his note of dissent, Subramanian calls for a looser fiscal policy. He states that the targets set by the committee are arbitrary and hard to justify. Instead, he proposes a single target to eliminate the general government primary deficit (in place of the highlight on the fiscal deficit) over a period of five years. He contends that this would ensure a declining path for debt, reassuring investors and making India’s fiscal trajectory more sustainable.

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