INTRODUCTION Fiscal Responsibility and Budget Management Act, 2003 by SUMBUL FAROOQUEE on MAY 19, 2011 Physicians say

of consumption, that in the early stages of this disease it is easy to cure but difficult to diagnose; whereas later on, if it has not been recognized and treated at the beginning, it becomes easy to diagnose and difficult to cure. The same thing happens in affairs of State. -Machiavelli The Fiscal Responsibility and Budget Management Act, 2003 (FRBMA) was enacted by the Parliament of India to institutionalize financial discipline, reduce Indias fiscal deficit, improve macroeconomic management and the overall management of the public funds by moving towards a balanced budget. The main purpose was to eliminate revenue deficit of the country (building revenue surplus thereafter) and bring down the fiscal deficit to a manageable 3% of the GDP by March 2008. However, due to the 2007 international financial crisis, the deadlines for the implementation of the targets in the act was initially postponed and subsequently suspended in 2009. In 2011, Economic Advisory Council publicly advised the Government of India to reconsider reinstating the provisions of the FRBMA. THE BACKGROUND The historical balance of payments crisis of India resulted in several radical changes to the Indian economy, including the process of economic liberalization in India. Due to the deplorable financial condition of India, subsequent governments formed several commissions and laws to improve the financial situation of the country. By the year 2000, at the central government level, India was running total liabilities equivalent to 6 times its annual revenue. The interest payments alone were consuming one-thirds of the tax revenue of India due to increased Government borrowings to fund the persistently rising revenue deficits of the country. In the light of this need for change, the NDA government introduced the Fiscal Responsibility and Budget Management Bill in year 2000 which subsequently went on to become the Fiscal Responsibility and Budget Management Act, 2003. The Gramm RudmanHollings Balanced Budget Act of the USA and Stability and Growth Pact of the European Union are widely considered the international forerunners to this act. The Fiscal Responsibility and Budget Management Bill (FRBM Bill) was introduced in India by the then Finance Minister of India, Mr.Yashwant Sinha in December, 2000. Firstly, the bill highlighted the terrible state of government finances in India both at the Union and the state levels under the statement of objects and reasons. Secondly, it sought to introduce the fundamentals of fiscal discipline at the various levels of the government.The FRBM bill was

introduced with the broad objectives of eliminating revenue deficit by 31 Mar 2006, prohibiting government borrowings from the Reserve Bank of India three years after enactment of the bill, and reducing the fiscal deficit to 2% of GDP (also by 31st Mar 2006). Further, the bill proposed for the government to reduce liabilities to 50% of the estimated GDP by year 2011. Political debate ensued in the country. Several revisions later, it resulted in a much relaxed and watered-down version of the bill (including postponing the date for elimination of revenue deficit to 31 March 2008) with some experts, like Dr Saumitra Chaudhuri of ICRA Ltd. (and now a member of Prime Ministers Economic Advisory Council) commenting, all teeth of the Fiscal Responsibility Bill have been pulled out and in the current form it will not be able to deliver the anticipated results. This bill received the assent of the President of India on 26th August 2003. Subsequently, it came into effect on 5 July 2004. However some of its most effective and important clauses had been diluted. Experience reveals different approaches to fiscal responsibility legislation. In particular, it is important to distinguish fiscal responsibility legislation that establishes certain reporting standards from that which sets specific fiscal targets and that which involves some combination of both approaches. In India, we have shifted from one approach of fiscal legislation top another, specifying fiscal targets in the former and establishing certain standards in the latter. Due to such a shift, we are ending up achieving the objectives of neither. NEED FOR SUCH A LEGISLATION The Central Government had been borrowing endlessly from the Reserve Bank of India and its internal debt is among the highest in the world. World Bank says that India has less External debt than most others. In terms of high Central budgetary deficit in 1997, India ranked tenth, after Greece, Turkey and Pakistan, among others. High deficits at the State Government levels have further compounded the problem. According to the IMF, Weak revenue performance and lack of expenditure control at both the central and state government levels caused the consolidated deficit of the public sector to rise sharply to around 11 per cent of GDP in FY 1990s with public sector debt exceeding 80 per cent of GDP. The deficit and debt has attracted focused attention with the introduction of the Fiscal Responsibility and Budget Management Bill in the Lok Sabha in December 2000. Five aspects of the deficit problem have attracted attention. First, is the deficit itself, which is a large proportion of GDP.

Second, is the composition of the deficit, in particular the sizable revenue deficit that goes to finance current consumption of the government, and the primary deficit, which is the fiscal deficit less interest payments. Third, is the growing debt, which is the accumulated deficit from the past. Fourth, is the growing interest burden on public debt, which is an obligatory expenditure and constrains the flexibility available with the government in resource allocation. Fifth, is the financing a part of the high deficit through borrowings from the Reserve Bank of India. There was a widespread unanimity about the unsustainability of the Indian fiscal stance. Taking into account defence revenue expenditure, major subsidies and transfer to States, there was nothing left after interest payment and the Center had to borrow to meet other items of revenue expenditure. Thus, there was a desperate need for a legislation on the ceiling of the expenditure of the Central Government and to put a cap on Government borrowings. OBJECTIVES 1. To introduce transparent fiscal management systems in the country 2. To introduce a more equitable and manageable distribution of the countrys debts over the years 3. To aim for fiscal stability in India in the long run. 4. To ensure macro-economic stability

IMPORTANT PROVISIONS Since the act was primarily for the management of the governments behavior, it provides for certain documents to be tabled in the Parliament annually with regards to the countrys fiscal policy. This includes the following along with the Annual Financial Statement and demands for grants: 1. Medium-term Fiscal Policy Statement This report presents a three-year rolling target for the fiscal indicators with assumptions, if applicable. This statement was to further include an assessment of sustainability

with regards to revenue deficit and the use of capital receipts of the Government (including market borrowings) for generating productive assets. 2. Fiscal Policy Strategy Statement A tactical report enumerating strategies and policies for the upcoming Financial Year including strategic fiscal priorities, taxation policies, key fiscal measures and an evaluation of how the proposed policies of the Central Government conform to the Fiscal Management Principles of this act. 3. Macro-economic Framework Statement This report contains forecasts enumerating the growth prospects of the country. GDP growth, revenue balance, gross fiscal balance and external account balance of the balance of payments were some of the key indicators to be included in this report. 4. The Act further required the government to develop measures to promote fiscal transparency and reduce secrecy in the preparation of the Government financial documents including the Union Budget. Fiscal management principles The Central Government, by rules made by it, was to specify the following: 1. a plan to eliminate revenue deficit by 31 Mar 2008 by setting annual targets for reduction starting from day of commencement of the act. 2. reduction of annual fiscal deficit of the country 3. annual targets for assuming contingent liabilities in the form of guarantees and the total liabilities as a percentage of the GDP

Borrowings from Reserve Bank of India The Act provides that the Central Government shall not borrow from the Reserve Bank of India(RBI) except under exceptional circumstances where there is temporary shortage of cash in particular financial year. It also laid down rules to prevent RBI from trading in the primary market for Government securities. It restricted them to the trading of Government securities in the secondary market after a April, 2005, barring situations highlighted in exceptions paragraph.

Exceptions National security, natural calamity or other exceptional grounds that the Central Government may specify were cited as reasons for not implementing the targets for fiscal management principles, prohibition on borrowings from

RBI and fiscal indicators highlighted above, provided they were approved by both the Houses of the Parliament as soon as possible, once these targets had been exceeded.

Measures to enforce compliance This was a particularly the weak area of the act. It required the Finance Minister of India to only conduct quarterly reviews of the receipts and expenditures of the Government and place these reports before the Parliament. Deviations to targets set by the Central government for fiscal policy had to be approved by the Parliament. No other measures for failure of compliance have been specified. Targets and fiscal indicators Subsequent to the enactment of the FRBMA, the following targets and fiscal indicators were agreed by the Central government:[4][13] Revenue deficit Date of elimination - 31 March 2009 (postponed from 31 March 2008) Minimum Annal reduction - 0.5% of GDP Fiscal Deficit Ceiling - 3% of the GDP by 31st Mar 2008 Minimum Annal reduction - 0.3% of GDP Total Debt - 9% of the GDP (a target increased from the original 6% requirement in 2004-05) Annual Reduction - 1% of GDP RBI purchase of Government bonds to cease from 1 April 2006 Four fiscal indicators to be projected in the medium term fiscal policy statement were proposed. These are, revenue deficit as a percentage of GDP, fiscal deficit as a percentage of GDP, tax revenue as percentage of GDP and total outstanding liabilities as percentage of GDP.[13 Four fiscal indicators to be projected in the medium term fiscal policy statement were proposed :1 Revenue deficit as a percentage of GDP 2 Fiscal deficit as a percentage of GDP 3. Tax revenue as percentage of GDP and 4 Total outstanding liabilities as percentage of GDP

he Fiscal Responsibility and Budget Management Rules, 2004 1.Reduction of revenue deficit by an amount equivalent of 0.5 per cent or more of the GDP at the end of each financial year, beginning with 2004-05. 2.Reduction of fiscal deficit by an amount equivalent of 0.3 per cent or more of the GDP at the end of each financial year, beginning with 2004-05. 3.No assumption of additional liabilities (including external debt at current exchange rate) in excess of 9 per cent of GDP for the financial year 2004-05 and progressive reduction of this limit by at least one percentage point of GDP in each subsequent year. 4.No guarantees in excess of 0.5 per cent of GDP in any financial year, beginning with 2004-05. 5.For greater transparency in the budgetary process, rules mandate the Central Government to disclose changes, if any, in accounting standards, policies and practices that have a bearing on the fiscal indicators. The Government is also mandated to submit statements of receivables and guarantees and a statement of assets, at the time of presenting the annual financial statement, latest by Budget 2006-07. 6.The rules prescribe the form for the quarterly review of the trends of receipts and expenditures.

Jurisdiction The residuary powers to make rules with respect to this act were with the Central Government with subsequent presentation before the Parliament for ratification. Civil courts of the country had no jurisdiction for enforcement of this act or decisions made therein. The power to remove difficulties was also entrusted to the Central Government. Criticism Subsequent Finance Minister Mr. P. Chidambaram, criticized the act and its rules as adverse since it required the government to cut back on social expenditure necessary to create productive assets and general upliftment of rural poor of India. The vagaries of monsoon in India, the social dependence on agriculture and over-optimistic projections of the task force in-charge of

developing the targets were highlighted as some of the potential failure points of the Act. However, other viewpoints insisted that the act would benefit the country by maintaining stable inflation rates which in turn would promote social progress. Some others have drawn parallel to this acts international counterparts like the Gramm-Rudman-Hollings Act (US) and the Growth and Stability Pact (EU) to point out the futility of enacting laws whose relevance and implementation over time is bound to decrease. They described the law as wishful thinking and a triumph of hope over experience. Parallels were drawn to the US experience of enacting debt-ceilings and how lawmakers have traditionally been able to amend such laws to their own political advantage. Similar fate was predicted for the Indian version which indeed was suspended in 2009 when the economy hit rough patches. Suspension and reinstatement Implementing the Act, the government had managed to cut the fiscal deficit to 2.7% of GDP and revenue deficit to 1.1% of GDP in 200708. However, given the international financial crisis of 2007, the deadlines for the implementation of the targets in the act were suspended. The fiscal deficit rose to 6.2% of GDP in 2008-09 against the target of 3% set by the Act for 200809. However, IMF estimated fiscal deficit to be 8% after accounting for oil bonds and other off budget expenses. In August 2009, IMF had opined that India should implement fiscal reform at the soonest possible, enacting a successor to the current act. This IMF paper was authored by two senior IMF economists Alejandro Sergio Simone and Petia Topalova and highlighted the shortcomings of the current law along with proposed improvements for a new version. It was also reported that the Thirteenth Finance Commission of India was working on a new plan for reinstating fiscal management in India. The initial expectation for revival of fiscal prudence was in 2010-11 but was further delayed. Finally, the government did announce a path of fiscal consolidation starting from fiscal deficit of 6.6% of GDP in 2009-10 to a target of 3.0% by 2014-15. However, eminent economist and ex-RBI Deputy Governor, S.S.Tarapore is quick to highlight the use of creative accounting to misrepresent numbers in the past. Furthermore, he added that fiscal consolidation is indeed vital for india, as long as the needs of the poor citizens are not marginalised. This need for financial inclusion of the poor while maintaining the fiscal discipline was highlighted by him as the most critical requirement for the 2011-12 Budget of India. More recently, PMEAC has stated the need for reinstatement of fiscal discipline of the Government of India, starting 201112 financial year. LOOP HOLES IN THE LEGISLATION

The table gives a very clear picture as to how Lok Sabha diluted the bill under the pretext of making the rules less stringent for future government, and not curtailing its development expenditure. The various reasons given are that this is binding on all future governments, and post 2001 is not the best time to tie the hands of the government, and all other unforeseen circumstances, which may make it difficult to stick to such legislation.

Provisions as introduced in 2000 Fiscal Deficit means a) The excess of total disbursements, from the consolidated fund of India, excluding repayment of debt, over total receipts into Fund, excluding debt receipts. b) Total expenditure of Consolidated Fund of India (including its loans but excluding repayment of debt) over its tax and non-tax receipts. 4. Fiscal Management principles.(1) The Central Government shall respond appropriately to eliminate the revenue deficit and fiscal deficit and build up adequate revenue surplus. (2) In particular, and without

Amendments Fiscal Deficit means -the excess of total disbursements, from the consolidated fund of India, excluding repayment of debt, over total receipts into Fund

Effect of these Amendments The definition of fiscal deficit has been narrowed by excluding debt, which is nowhere close to a negligible figure.

The Central government shall take appropriate steps to reduce fiscal deficit and eliminate revenue deficit by the 31st March 2008 and there after build up

All the targets have been removed to achieve the required deficit level and it has been left to the whims of the government to decide for every

prejudice to the generality of the foregoing provision, the Central Government shall (a) Reduce revenue deficit by an amount equivalent to one-half per cent. Alternatively, 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 5. Borrowing from Reserve Bank.(1) The Central Government shall not borrow from the Reserve Bank. (2) Notwithstanding anything contained in subsection (1), the Central Government may borrow

adequate revenue surplus. The annual targets for reduction of fiscal deficit and revenue deficit during the period beginning with the commencement of this act and ending on 31st March 2008.

financial year. It is also not binding in nature i.e. the Central government can exceed the deficit target for the year.

3) The Reserve Bank may subscribe, on or after the period specified in this subsection, to the primary issues of the central Government securities due to grounds of National security or National calamity.

This amendment allows the central Government to monetize its budget deficit on grounds of national security or calamity even after the

from the Reserve Bank by way of advances to meet temporary excess of cash disbursement over cash receipts during any financial year in accordance with the agreements, which may be entered into by that Government with the Reserve Bank: Provided that any advances made by the Reserve Bank to meet temporary excess cash disbursement over cash receipts in any financial year shall be repayable in accordance with the provisions contained in subsection (5) of section 17 of the Reserve Bank of India Act, 1934 (2 of 1934). (3) Notwithstanding anything contained in sub-section (1), the Reserve Bank may subscribe to the primary issues of the Central Government securities during the financial year beginning on the 1st day of April 2001 and subsequent two financial years 6. Measures for fiscal transparency.-(1) The Central 2) The Central

prescribed limit of two years, which is in the bill. Therefore, this clause is killing the initial objective of the bill of putting a cap on Government borrowings. This clause removes any kind of ceiling on government borrowing that the bill may have intended to have.

Again, it is left to the

Government shall take suitable measures to ensure greater transparency in its fiscal operations in public interest and minimize as far as practicable, secrecy in the preparation of the annual budget. (2) In particular, and without prejudice to the generality of the foregoing provision, the Central Government shall, at the time of presentation of the annual budget, disclose in a statement as may be prescribed, (a) The significant changes in the accounting standards, policies and practices affecting or likely to affect the computation of prescribed fiscal indicators; (b) As far as practicable, and consistent with protection of public interest, the contingent liabilities created by way of guarantees including guarantees

Government shall at the time of any such presentation of annual financial statements or demand for grants, make such disclosures and in such form as may be prescribed.

central Government at the time of its presentation whether it chooses to stick to the principles of fiscal transparency.

to finance exchange risk on any transactions, all claims and commitments made by the Central Government having potential budgetary implications, including revenue demands raised but not realised and liability in respect of major works and contracts.

LIMITATIONS

These limitations of FRBM Act which hinder the achievement of targets are as follows:1.Neglect of equity and growth FRBM Act 2003 is heavily loaded against investment in both human development and infrastructure sector. One of the major omission of amended FRBM Bill 2000 or FRBM Act 2003 was complete absence of any target for time bound minimum improvement in areas of power generation, transport, etc. which is very important both from the point of equity and higher economic growth. 2.Non-Coverage of State Governments The provisions of the bill impose restrictions on the central government only but state governments are out of its scope. But, deficits of state governments are as much or even a greater problem. 3. Neglect of Development Needs Today, the levels of capital expenditures by the government are miserably low in India. These capital expenditures increase the efficiency and

productivity of private investment and thus contribute to the development process in the country. If Revenue Deficit is to be reduced to zero and GFD to be 2% of GDP as per the requirement of FRBM A, it is the capital expenditure which will be sacrificed and thus will hinder further development of the country. 4. Need to Increase Revenue Revenue deficits are determined by the interplay of expenditure and revenues. Too often, attention gets focused only on the expenditure side of the identity neglecting the revenue side. Increasing non-tax revenue requires that public sector services be appropriately priced, which may be difficult as the present society has got used to the subsidized education, health, food items, etc. 5. Neglect of Social Sector The FRBMA does not mention anything relating to social sector development. However, investment in social sector such as health, education, etc is very vital for the economic development of the nation.

6. Problem of Subsidies The government may be able to reduce revenue deficit by reducing subsidies. However, it is quite likely that the government will be under severe pressure to continue the subsidies. It means the expenditure on the productive areas Stable Growth Deficit The overall fiscal deficit termed as stable growth deficit of the government sector as a whole should be pegged at 6% of GDP with revenue deficit being gradually phased out. Thus, the target of 2% of fiscal deficit GDP ratio stated in FRBMA is not desirable from the point of view of productive investment.

8. False Assumptions The FRBMA is based on the following assumptions :-

1.Lower fiscal deficit lead to higher growth. 2.Larger fiscal deficit lead to higher inflation 3.Larger fiscal deficit increase external vulnerability of the economy. These assumptions can be rejected by the following arguments :1.If the deficit is in the form of capital expenditure it would contribute to future growth. 2.Fiscal deficit is not only the cause for higher inflation. During the late 1990s the rate of inflation has fallen even when the fiscal deficit was as high as 5.5% of GDP. 3.Higher fiscal deficit need not necessarily cause external crisis. The external vulnerability depends more on capital and trade account convertibility. In India we have managed to build large foreign exchange reserves, though fiscal deficit has not come down.

9. Absence of well defined accounting definitions for target fiscal indicators.

Accounting and definitional procedures underpinning the FRBMA are delegated to supporting rules that require the government to inform parliament of significant changes in accounting standards. Nevertheless, these rules do not contain exact definitions of the concepts underpinning the prescribed fiscal indicators. As a result ,and in order to meet targets, these ambiguities have been exploited by meeting current expenditure through the issue of special bonds (e.g., subsidy-related bonds).18 These creative accounting measures undermine the credibility of governments commitment to fiscal discipline.

10. Insufficient transparency in budget preparation

The FRBMA numerical targets were not supported by a comprehensive plan of medium-term policy measures for expenditures. At the time of the FRBMA implementation, measures on the revenue side were discussed in detail, and actual revenue performance was very close to the FRBMA roadmap. However, measures underpinning expenditure projections were kept at a very general level. Furthermore, the assumptions underpinning the budget do not always include annual forecasts for key macroeconomic variables such as GDP growth, inflation, imports, exports and the exchange rate. There is also insufficient discussion of fiscal risks. Such a discussion could have identified the impact of increased international oil prices on subsidies and recognized the risks of delays in subsidy reform. Absence of well-defined sanctions for non-compliance

Enforcement of the FRBMA relies on the loss of reputation that the government may experience from failing to meet the fiscal targets. Thus, there are no explicit penalties that are applied automatically when fiscal targets are missed and/or budget procedures are not followed. International experience shows that in countries with a history of weak fiscal discipline, Institutional sanctions (e.g., withholding of transfers, borrowing restrictions, and fines) and/or personal sanctions (e.g., fines, dismissal, and penal prosecution) come to the rescue. For example, in Brazil, the FRL specifies comprehensive institutional sanctions and is complemented by the Fiscal Crimes Law, which outlines stringent personal sanctions that can escalate up to penal prosecution.

12. Widely defined escape clauses

Breaches of the ultimate medium-term target, or of the annual targets set under the supporting rules are permitted for reasons of natural disaster, security or other circumstances specified by central government. In addition, corrective measures only kick in if there are very large deviations.

CURRENT SCENARIO

ROAD TO FISCAL CONSOLIDATION The experience with Fiscal Responsibility and Budget Management Act, 2003 (FRBM Act) at Centre and the corresponding Acts at State level show that statutory fiscal consolidation targets have a positive effect on macroeconomic management of the economy. In the course of the year the Central Government would introduce an amendment to the FRBM Act, laying down the fiscal road map for the next five years. The Thirteenth Finance Commission has worked out a fiscal consolidation road map for States requiring them to eliminate revenue deficit and achieve a fiscal deficit of 3 per cent of their respective Gross State Domestic Product latest by 2014-15. It has also recommended a combined States debt target of 24.3 percent of GDP to be reached during this period. The States are required to amend or enact their FRBM Acts to conform to these recommendations.

The effective management of public expenditure is an integral part of the fiscal consolidation process. Expenditure has to be oriented towards the production of public goods and services. The extant classification of public expenditure between plan, non-plan, revenue and capital spending needs to be revisited. This is necessary as one recognizes the importance of service sector and the knowledge economy for our development. A Committee under Dr. C. Rangarajan has been set up by the Planning Commission to look into these issues.

REVISED ESTIMATES

BUDGET ESTIMATES

TARGET

TARGET

(2010-11) REVENUE DEFICIT FISCAL DEFICIT GROSS TAX REVENUE TOTAL OUTSTANDING LIABILITIES 3.4 5.1 10.0

(2011-12) 3.4 4.6 10.4

(2012-13) 2.7 4.1 10.8

(2013-14) 2.1 3.5 11.3

45.3

44.2

43.1

41.5

FISCAL INDICATORS ROLLING TARGETS AS % OF GDP

RECOMMENDATIONS OF 13TH FINANCE COMMISSION <![if !supportLists]>1. <![endif]>The FRBM Act needs to specify the nature of shocks that would require a relaxation of FRBM targets. <![if !supportLists]>2. <![endif]>States should amend/enact FRBM Acts to build in the fiscal reform path worked out. State-specific grants recommended for a state should be released upon compliance. <![if !supportLists]>3. <![endif]>Independent review/monitoring mechanism under the FRBM Acts should be set up by states. <![if !supportLists]>4. <![endif]>For states that have not availed the benefit of consolidation under the Debt Consolidation and Relief Facility (DCRF), the facility, limited to consolidation and interest rate reduction, should be extended, subject to enactment of the FRBM Act. <![if !supportLists]>5. <![endif]>The benefit of interest relief on NSSF and the write-off should be made available to states only if they bring about the necessary amendments/enactments of FRBM

CONCLUSION F RBM Act 2003 despite above criticism can play a very important role in controlling fiscal deficit and in bringing transparency in fiscal operation of the government if it is implemented effectively in letter and spirit by the concerned government. The spirit of the FRBM Act, 2003 envisages not only institutional dedication to fiscal discipline but also a qualitative improvement in the types of expenditure undertaken.

The way forward lies in continued emphasis on fiscal consolidation with focus on outcomes. The focus now should also be on expenditure reform in order to make the fiscal consolidation process sustainable and bring in intergenerational equity in fiscal management. Without putting at risk the economic revival process, the Government will look at exit strategies as soon as there is improvement in economic conditions.

The Thirteenth Finance Commission through an additional Term of Reference has been mandated to review the roadmap for fiscal adjustment and suggest a suitably revised roadmap to maintain the gains of fiscal consolidation through 2010 to 2015, particularly keeping in view the need to bring in the liabilities of the Central Government on account of oil, food and fertiliser bonds into the fiscal accounting, and the impact of various other obligations of the Central Government on the deficit targets.