FRBM Act & Fiscal Consolidation
🟠 Topic 58: FRBM Act & Fiscal Consolidation
📌 Introduction
A fiscally responsible government is key to ensuring macroeconomic stability and sustainable economic growth. The Fiscal Responsibility and Budget Management (FRBM) Act, 2003 was enacted to institutionalize fiscal discipline, improve the management of public funds, and ensure long-term fiscal sustainability. The Act plays a crucial role in India’s fiscal consolidation framework, defining fiscal deficit targets and ensuring transparency in public finance.
🔹 What is Fiscal Consolidation?
📖 Definition
Fiscal consolidation refers to policy measures undertaken by the government to reduce fiscal deficit and public debt levels in a sustainable manner, ensuring long-term fiscal health without compromising on economic growth.
🔹 Background of FRBM Act
📖 Historical Context
- Prior to the 1991 reforms, India experienced high fiscal deficits exceeding 6% of GDP.
- Excessive borrowing led to: ✔️ High inflation.
✔️ Rising interest payments.
✔️ Macroeconomic instability.
Enactment
- Passed in 2003 and came into effect from July 5, 2004.
- Aimed to institutionalize fiscal discipline, reduce fiscal deficit, and improve macroeconomic management.
🔹 Key Objectives of FRBM Act
✔️ Ensure inter-generational equity in fiscal management.
✔️ Achieve long-term macroeconomic stability.
✔️ Improve transparency in fiscal operations.
✔️ Promote public accountability in managing government finances.
🔹 Key Provisions of FRBM Act
1️⃣ Fiscal Deficit Target
- Original Target: Reduce fiscal deficit to 3% of GDP by 2008-09.
- Allowed flexibility for external shocks and exceptional circumstances (natural calamities, security threats).
2️⃣ Revenue Deficit Target
- Eliminate revenue deficit to ensure that borrowing is used only for capital expenditure (asset creation).
3️⃣ Annual Fiscal Roadmap
- The government must present: ✔️ Medium-Term Fiscal Policy Statement. ✔️ Fiscal Policy Strategy Statement. ✔️ Macroeconomic Framework Statement.
4️⃣ Transparency Measures
- Mandatory disclosure of contingent liabilities, tax expenditures, and other fiscal risks.
- Off-budget borrowings to be transparently reported.
5️⃣ Escape Clause
- Fiscal targets may be relaxed during: ✔️ War or national security threats. ✔️ Natural calamities. ✔️ Collapse of agriculture or banking sectors.
🔹 Amendments to FRBM Act
1️⃣ 2012 Amendment
- Introduced the concept of Effective Revenue Deficit, which excludes capital transfers to states.
- Focused on improving quality of deficit (borrowing for productive purposes).
2️⃣ 2018 Amendment (Post-NK Singh Committee Recommendations)
| Target | Revised Limit |
|---|---|
| Fiscal Deficit | 3% of GDP (with flexibility of 0.5% in case of shocks) |
| Debt to GDP Ratio | To be reduced to 60% (Central + State Govt.) |
| Revenue Deficit | Targeted to be reduced progressively |
Fiscal Council Recommendation
- Proposed independent Fiscal Council to oversee compliance with FRBM targets (yet to be implemented).
🔹 Current Status – Post COVID-19
- Due to COVID-19 pandemic, fiscal deficit targets were relaxed.
- Fiscal deficit in 2020-21 touched 9.2% of GDP.
- FRBM targets suspended temporarily to allow fiscal stimulus.
🔹 Importance of Fiscal Consolidation
1️⃣ Ensuring Macroeconomic Stability
- High fiscal deficit can crowd out private investment.
- Excessive borrowing leads to higher interest rates.
2️⃣ Boosting Investor Confidence
- Adhering to fiscal discipline enhances credit ratings and attracts foreign investment.
3️⃣ Reducing Interest Payments
- Fiscal consolidation reduces debt servicing costs, freeing resources for development expenditure.
4️⃣ Ensuring Inter-generational Equity
- Avoid burdening future generations with excessive debt.
🔹 Key Fiscal Consolidation Measures in India
| Measure | Description |
|---|---|
| Tax Reforms | GST for efficient tax collection |
| Disinvestment | Sale of government stake in PSUs |
| Expenditure Rationalisation | Targeted subsidies, outcome-based budgeting |
| Debt Management | Shift to long-term, low-cost borrowings |
| Public Sector Reforms | Reducing budgetary support to loss-making PSUs |
Case Study – Fiscal Consolidation during 2003-08
- Post FRBM implementation, fiscal deficit fell from 5.9% in 2002-03 to 2.5% in 2007-08.
- Focus on higher tax revenue, better expenditure control.
- Enabled higher public investment in infrastructure.
🔹 Challenges to Fiscal Consolidation in India
1️⃣ Populist Spending
- Pre-election spending increases subsidies, welfare transfers.
- Difficult to cut popular schemes.
2️⃣ Tax Evasion
- Informal economy and tax evasion reduce tax-to-GDP ratio.
3️⃣ High Subsidy Burden
- Subsidies on food, fertilizer, fuel put pressure on fiscal health.
4️⃣ Contingent Liabilities
- Off-budget borrowings and sovereign guarantees add to hidden liabilities.
5️⃣ Centre-State Fiscal Relations
- States’ fiscal consolidation crucial, but debt-to-GDP ratios in states remain high.
🔹 Role of N.K. Singh Committee (2016)
- Recommended: ✔️ Debt-to-GDP Target of 60% (Central 40%, States 20%).
✔️ Setting up Fiscal Council.
✔️ Flexibility for counter-cyclical fiscal policy (escape clause).
✔️ Focus on quality of expenditure — prioritize capital spending.
🔹 Fiscal Consolidation & 15th Finance Commission
- Recommended: ✔️ Maintain fiscal deficit within 4% (FY21) and reduce gradually. ✔️ Improve tax-to-GDP ratio through tax reforms. ✔️ Improve expenditure efficiency via better targeting.
📊 India’s Fiscal Deficit Trend
| Year | Fiscal Deficit (% of GDP) |
|---|---|
| 2018-19 | 3.4% |
| 2019-20 | 4.6% |
| 2020-21 (COVID) | 9.2% |
| 2023-24 (BE) | 5.9% |
📚 Practice MCQ
1️⃣ Consider the following statements about FRBM Act:
- It aims to eliminate revenue deficit and reduce fiscal deficit.
- It mandates transparency in fiscal operations through disclosure requirements.
- It applies only to the Central Government, not to State Governments.
Which of the above statements are correct?
✅ Options:
(a) 1 and 2 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2, and 3
2️⃣ Which committee recommended the creation of a Fiscal Council under FRBM reforms?
✅ Options:
(a) Kelkar Committee
(b) Rangarajan Committee
(c) N.K. Singh Committee
(d) C. Rangarajan Committee
3️⃣ What is the recommended debt-to-GDP target for Central Government under FRBM amendments?
✅ Options:
(a) 30%
(b) 40%
(c) 50%
(d) 60%
