The FRBM Act Needs More Teeth

A new FRBM Act with more teeth as well as an independent fiscal council are ideas that need to get into public discourse.

Isher Judge Ahluwalia was supposed to have said  at a meeting of economists at the erstwhile Planning Commission-

The FRBM [Fiscal Responsibility and Budget Management Act] is like a chastity belt, you should not loosen it, without good reason.

The Commission was then headed by her husband, Montek Singh Ahluwalia and, if my memory serves me right, the meeting was about the approach to the Eleventh Plan.

Finance minister Arun Jaitley is getting similar advice from one set of people. There’s another set which is telling him it’s okay to loosen it just a mite. We’ll know on 29 February which path he intends to follow, but there’s no getting away from the fact that a law that was meant to check fiscal promiscuity by governments has hopelessly failed. As former finance minister Yashwant Sinha, the architect of the legislation said in this interview to Swarajya  “it is dead.”

So, is a new law the answer? The Fourteenth Finance Commission (FFC) thought so, but wanted one with more teeth. It recommended  a new Debt Ceiling and Fiscal Responsibility Act, which specifically invokes Article 292 of the Constitution.

This Article allows Parliament to set limits on borrowing by the government (hence setting the fiscal deficit, which is the gap between total receipts and total expenditure, indicating how much the government needs to borrow) as well as giving of guarantees by the government.

But will the political class legislate a stricter law, when even the current one is just a few pieces of paper? Consider the 12-year history of the current FRBM Act, 2003, which is a pale shadow of the original Bill that Sinha tabled in 2000.

That Bill not only explicitly mentioned the goals of eliminating the revenue deficit and reducing the fiscal deficit to two percent of GDP, but also specified the yearly reduction targets (0.5 percent a year) and date (March 2006) as well as the cap on contingent liabilities (0.5 percent of GDP). This would have made shifting the goalposts difficult, since the law would have to be amended each time.

But the parliamentary standing committee on finance objected to the mention of specific targets in the Bill and said that it would tie the government down. Ultimately, the Act only mentioned the year for elimination of revenue deficit and reduction of fiscal deficit (2008, instead of 2006). The fiscal deficit target (increased to three percent) as well as yearly targets and cap on contingent liabilities (all 0.5 percent of GDP) got pushed to the rules, enabling them to be easily changed by an executive order.

The United Progressive Alliance (UPA) government claims credit for notifying the FRBM Act in 2004 and bringing it into force (it was passed in 2003), but it blithely shifted fiscal goalposts whenever it wanted. And the opposition parties never really put it on the mat for these successive breaches.

Consider this chronology:

July 2004 budget: UPA finance minister P. Chidambaram relaxed the deadline for eliminating the revenue deficit to March 2009, citing the National Common Minimum Programme that the Congress and the left parties had arrived at.

February 2005: Pause button pressed on yearly reduction target because of the report of the Twelfth Finance Commission; 2008-09 continued to be the deadline year.

February 2008: Revenue deficit elimination target deferred by a year. That budget had three big announcements – the implementation of the Sixth Pay Commission award, the massive farm loan waiver and the expansion of the NREGA from 200 districts to all districts.

February 2009 interim budget: Pranab Mukherjee, now the finance minister, cites global meltdown and stimulus package as reasons why the government had decided to relax the FRBM targets.

February 2012: FRBM Act amended and deficit reduction targets pushed to 2015.

February 2013: deficit reduction targets further pushed to 2018.

Is there any point in a FRBM law, then? In fact, in the early 2000s when the law was being debated, there was a point of view that since Parliament was approving the budget, it was also approving the borrowing programme of the government (which is really the fiscal deficit) and that there was no need for a separate law.

But M. Govind Rao, member of the FFC and former director of the National Institute of Public Finance and Policy (NIPFP) poses a counterfactual – what would have happened if the FRBM did not exist at all? Right now, he points out, even a minor 0.2 percent relaxation of the deficit target has kicked off a huge debate. Without the FRBM Act, governments would have had unbridled freedom to be fiscally imprudent.

Poor budget maths often results in fiscal consolidation targets going haywire. The Mid Year Economic Analysis 2014-15 red-flagged the massive overestimation of revenue in that year’s budget. In the 2008-09 budget, the revenue deficit was budgeted at 1.1 percent despite the three big expenditure programmes.

Rao had pointed out soon after that the deficit was likely to be much higher and he was proven right. The revenue deficit soared to 4.5 percent and the fiscal deficit to 6 percent (Rao says it was actually 7.5 percent because the oil pool deficit was kept under a separate head). The deficit was blamed on the global meltdown that happened later in the year but that, says Rao, came as a convenient excuse for the government; there would have been a fiscal problem even if the world economy had not crashed.

That is why Rao roots for an independent fiscal council, another recommendation in the FFC report. The report had suggested the existing FRBM Act be amended to set this up (this was an alternative to enacting a new law). Over 30 countries have such a body, with varying degrees of effectiveness.

The council, the FFC said, would undertake an ex ante analysis of the financial implications of budget proposals and test them for soundness. That should check overestimation of revenues and underestimation of expenditures which are a common feature. Seven of the last eight budgets, Rao points out, had a revenue shortfall of more than 10 percent vis-à-vis budget estimates.

In addition, Rao also suggests that the fiscal council could also undertake a cost analysis of government policies and programmes – not just the immediate cost implications but future liabilities as well. A third responsibility could be monitoring the adherence to fiscal targets during the course of a financial year and flagging any likely deviations or stresses.

The fiscal council would submit its report to Parliament (like the Comptroller and Auditor General does) and thus be an independent voice. It could exert some kind of moral pressure on the government to be fiscally prudent or, at the very least, it could show up any dodgy fiscal maths.

In 2012, the FRBM Act was amended to allow the CAG the periodically monitor the compliance with the provisions of the Act. But the FFC found this inadequate – this was an ex-post review; what is needed is an ex-ante review.

The Thirteenth Finance Commission had also suggested a similar body. The UPA government did not pick up that ball, nor has this government said anything about the FFC recommendation. But a new FRBM Act with more teeth as well as an independent fiscal council are ideas that need to get into public discourse. Isher Ahluwalia was right: the chastity belt shouldn’t be loosened without good reason.