FRBM and Budget 2020

Debt and deficits – the two words that keep the government and its ambitious budgets in check. While governments would love to spend until their heart’s content, the fear of exceeding tax revenue and having to borrow (along with other macroeconomic reasons) reigns in government spending. 

The fiscal deficit is an important aspect of any budget because of the negative impacts of government borrowing on the macroeconomy. The notion is that the government would want to keep the fiscal deficit low out of concern for the economy’s health in the future. If the budget proposed is highly expansionary in nature, i.e. has a large fiscal deficit, the government will have to borrow money at some point to finance its plan of action. These loans and borrowings, while helpful in the short run, take a toll on the economy in the form of interest payments down the line. In the 1990s, the government was bleeding money every year in interest payments due to a high level of previous borrowings and skyrocketing Debt-to-GDP ratio (measure of debt to economic output). This put the Indian economy in a crisis and to prevent such a calamity from occurring again, a legal remedy was advised, that resulted in the formation of FRBM. 

FRBM and its Historical Roadmap: The Fiscal Responsibility and Budget Management Act targets the reduction of fiscal deficit by eliminating revenue deficit. It seeks to increase transparency and attain macroeconomic stability and financial discipline by efficiently managing debt and revenue. 

In 2003, Finance Minister Mr.Yashwant Sinha introduced the FRBM act to prevent India from falling into the Debt Trap. The act has a strict and rigid framework with tough targets to follow. Targets to be met by 31st March 2009 included eliminating the Revenue Deficit (Minimum annual reduction being 0.5% of the GDP) and Reducing fiscal deficit to 3% of GDP. The Act was amended in 2012 since the earlier targets were not met, with the next set of targets to be achieved by 31st March 2015. 

The act was amended for the second time in 2015 which was to be achieved by 2018. However, in 2016 a committee was set up to review the FRBM act. This committee was headed by Mr. NK Singh. The targets set by this committee required the Government to reduce the Revenue deficit to 0.8% of GDP by 31st March 2023 and fiscal deficit to be reduced to 2.5% of GDP by 31st March 2023. 

The new targets set by the NK Singh Committee want the targeted fiscal deficit to be further lowered and the targeted revenue deficit to be relaxed. This implies that capital expenditure will have to be reduced for these targets to be met. However, such a move will have an adverse effect on the economy’s long-term development prospects. 

Budget 2020 and FRBM: The FRBM Act mentions an escape clause that, in practice, works like a convenient loophole for the government to exploit and avoid accountability for their borrowing and debt. The Escape clause gives the government a buffer of 0.5 percentage points, allowing it to exceed its fiscal deficit targets by that amount. The clause can be exercised if the economy is under severe stress that requires high levels of government expenditure. It is also applicable to periods of structural change that can cause a decline in growth. The escape clause was exercised in the Union Budget 2020. 

On 1st February 2020, the Finance Minister of India, Ms. Nirmala Sitharaman announced in her budget speech, “Section 4 (2) of the FRBM Act provides for a trigger mechanism for a deviation from the estimated fiscal deficit on account of structural reforms in the economy with unanticipated fiscal implications. Therefore, I have taken a deviation of 0.5%, consistent with Section 4(3) of FRBM Act, both for RE 2019-20 and BE 2020-21.”

Implications of Exercising Escape Clause:The FRBM Act sought to bring India out of the debt crisis and the poor economic state.

However, economists predict that this decision of opting for the escape clause might take India back to the dark age; the period of managing fiscal deficits using ‘automatic monetization’. Till 1993, the RBI used to issue Ad-hoc Treasury Bills to help fill the gaps in government spending, i.e fiscal deficit. As expected, this method was highly inflationary in nature and faced severe criticism. The FRBM Act lead to this method being completely discontinued, however, Ad-Hoc Treasury Bills are not the only way the RBI could finance the fiscal deficit. The loopholes within the escape clause allow for other methods of deficit financing.

The 2018 amendments to the FRBM Act allow the RBI to buy government bonds in the primary auction directly. Ananth Narayan, a senior analyst at the Observatory Group mentioned in his pre-budget note that if the Escape clause is exercised then “it would further formalize the implicit deficit financing that is in the past few quarters” (“Budget 2020: Invoking Fiscal Escape Clause May Allow RBI to Buy Government Bonds Directly.”

If the RBI buys government bonds directly, as a way of financing the expenditure, it will take the form of deficit financing. More money will enter into circulation leading to higher monetary inflation. The 2020 Union Budget itself, as shown below, is expecting a fiscal deficit of 3.5% of the GDP. Some economists would judge this as an expansionary budget that is focused on boosting economic growth rates, being inconsiderate of the effects on inflation. With the Government’s already expansionary plan, exercising the Escape Clause can lead to the RBI possibly making the inflation rate in India much higher than what already exists. 

Apart from the risk of increasing inflation, the possible side-effect of using the escape clause is reckless government spending and lack of fiscal discipline. If the government is no longer bound by the piece of legislature that holds it accountable for spending, then it is likely that spending will become more careless. The question of efficiency arises as well. Does surpassing the FRBM targets increase the risk of inefficient use of taxpayer money?   Screen Shot 2020-02-21 at 3.25.25 PM

Long-Term Implications of the Budget: This budget goes against the very fundamentals of the FRBM Act. It seeks to increase revenue deficit and reduce the fiscal deficit which is only achievable by significantly cutting back on the capital expenditure. While decreasing the fiscal deficit is a step in the right direction, reducing capital expenditure is a dangerous move for the economy. For a country to sustain development and growth, the government must consistently invest in the country’s infrastructure and assets, which is a part of the capital expenditure. It is capital expenditure that yields results in the long-term. Not investing in these assets now will hurt the productive potential of the economy in the future. While revenue expenditure will boost the actual economic growth rate, it will do so at the cost of the future of the nation. Setting all other concerning factors like inflation and ‘setting the wrong precedence of reckless spending’ aside, just the lack of enough investment in capital is cause for worry. 

Clearly, there is a case of jumbled priorities in the Union Budget of 2020. Only time will tell if the government was able to strike the balance in the ‘jam today or more jam tomorrow’ problem. 

Works Cited

 

Bloomberg Quint, 29 Jan. 2020, https://www.bloombergquint.com/union-budget-2020/budget-2020-invoking-fiscal-escape-clause-may-allow-rbi-to-buy-government-bonds-directly

Advaita Singh is a first year student of Ashoka University pursuing her major in Economics.

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