Modi – government is reviewing the Fiscal Responsibility and Budget Management (FRBM) Act in the light of the economic crisis caused by the Covid-19 pandemic and adopt a flexible, range-bound fiscal deficit (FD) target instead of a fixed number. The issue was discussed at the Economic Advisory Council (EAC) of the 15th Finance Commission (XVFC) on September 4, 2020, wherein the chairman, NK Singh cited similar practice followed by the Reserve Bank of India’s (RBI) with +/- 2% inflation target while deciding its monetary policy.
The immediate prompt for this is sharp contraction in GDP (gross domestic product) by about 24% in the first quarter of current financial year and corresponding steep reduction in tax collections even as the expenditure commitments are on the upswing (courtesy, Stimulus I & II already given). As a result, on May 8, 2020, the government raised its gross market borrowing target for financial year (FY) 2020-21 to Rs 1200,000 crore from up from Rs 780,000 crore provided for in the Budget on February 1, 2020.
Of this, the government had already borrowed Rs 766,000 crore during the first half of the current FY and plans to borrow the remaining Rs 434,000 crore by January 2021. At Rs 1200,000 crore, the borrowing limit is already set at about 5.8% of GDP – 2.3% higher than the budgeted FD target of 3.5%. With this and demand for yet another Stimulus III gaining ground (the Finance Minister, Nirmala Sithraman appears to be responding to this as well), it is not surprising that the finance ministry is building pressure on XVFC to allow greater flexibility while fixing the target itself.
During the current year, we have an extraordinary situation (courtesy, pandemic); so one can understand the desperation. But, it is important to recall here that in his budget speech for 2016-17, the then finance minister, Arun Jaitely had announced the government’s intent to review FRBM Act (2003) with a view to make the target flexible (that the announcement was made following an year i.e. 2015-16 when it had achieved FD target of 3.9% sounds a bit anomalous). He had set up a committee under Mr NK Singh (it included among others, the then chief economic adviser, Arvind Subramanian and then deputy governor, RBI, Urjit Patel) to examine the issue.
The committee recommended a ‘glide path’ for the next six years beginning 2017-18. It recommended a fiscal deficit (FD) target of 2.5%, revenue deficit 0.8%, combined Centre-state debt ceiling of 60% and central debt ceiling of 40% for 2022-23. Further, it fixed 3% FD to be achieved during 2018-19. It also allowed the government to breach the target – by up to 0.5% — in case of “far-reaching structural reforms with unanticipated fiscal implications.”
In the amendment to the FRBM Act vide Finance Bill 2018-19, even while retaining the ‘escape clause’ to cover unanticipated events, the government adopted the glide path of achieving 3% fiscal deficit by 2020-21 instead of 2018-19 mooted by the committee. Further, it set the debt limit of 40% for the Centre to be reached by 2024-25 instead of the committee’s mandate of 2022-23.
This ‘cherry-picking’ may be seen in the backdrop of the government missing the FD target for 2017-18 by 0.3% (actual was 3.5% against the BE of 3.2%) and seeing no hope of achieving 3% during 2018-19 as recommended by the committee (actual FD in that year was 3.4% against the BE of 3.3%).
While, presenting the for Budget 2020-21, the incumbent FM Sitharaman has already invoked the escape clause of the FRBM Act to relax the FD targets for FY 2019-20 from 3.3% budget estimate (BE) to 3.8% in the revised estimate (RE) and for FY 2020-21 from 3% as per the glide path required under the Act to 3.5%. The one big thing that she did last year was steep reduction in the corporate tax rate which meant a revenue loss of close to Rs 150,000 crore annually. The reform was far reaching and structural but one wonders whether this was an event not anticipated by the government.
Ironically, the above numbers do not give the true picture of fiscal deficit as a lot of expenses despite being a liability of the sovereign government are kept off its balance sheet. These are deferred subsidy payments (DSPs) and extra-budgetary resources (EBRs) (a nickname for borrowings by public sector undertakings (PSUs) and other agencies of the government on its behalf). Including these off-balance sheet items, FD for 2017-18 and 2018-19 would be about 5.9% and 5.7% respectively. For 2019-20, including DSPs alone, FD would be 5.1%. Add EBRs, deficit will gallop.
For 2020-21, the likely deficit of 5.8% is exclusive of DSPs and EBRs. There is short provision in the budget: food subsidy about Rs 103,000 crore and fertilizer subsidy around Rs 80,000 crore. Plus there will be huge shortfall in proceeds from disinvestment by at least Rs 150,000 crore as big ticket sales such as Bharat Petroleum Corporation Limited (BPCL) and Life Insurance Corporation (LIC) are unlikely to go through during the current year. This adds up to 2% taking the total to 7.8%. Including EBRs, FD could touch 10%!
Already, under the existing dispensation of FD being a fixed number, the government is having a lot of leeway – explicit as well as not so explicit. On the explicit side, we have seen the fiscal consolidation glide path made fairly liberal to suit the budget math as also the revised FD being significantly higher than the target – yet going unpunished (for instance, during 2008-09, actual FD was 6% against the target of 3% as per FRBM Act, 2003). On the not so explicit side, DSPs and EBRs have been used brazenly to camouflage the true deficit.
On top of all this, if fiscal deficit range gets embedded in the FRBM Act, this will tantamount to giving legal sanction to slippages. It will defeat the very purpose of fixing target which is to obligate the government to keep the excess of its expenses over revenue within specified limit. The moment the law itself prescribes a range say 3% – 3.5%, even the most discerning government will take higher end of the range as the benchmark as from a legal standpoint, violation will happen only when actual exceeds 3.5%.
To put it differently, providing for a range is a more subtle and sophisticated way of embedding in the legislation a more relaxed target (as the lower end of the range anyway becomes redundant) without catching the attention of not so discerning eye.
The comparison with inflation targeting under monetary policy to justify FDI range is not all fours. While, FD target has a direct bearing on budgeting by Centre (a swing of 0.1% either way makes a difference of Rs 20,000 crore in its borrowing limit), inflation targeting by RBI does not impact the finances of banks. For a proper comparison, we need to look at the RBI mandated ‘provisioning’ for a loan that becomes NPA. That is a fixed number say 25% (for an account remaining unpaid for up to one year), not a range.
It is argued that a range brings an element of ‘predictability’ in knowing how far the government can go in expanding its borrowing program and resultant impact on crucial parameters like bond yields, interest rate etc; hence helpful in boosting investor confidence. This is a frivolous argument. Whether, it is one fixed number or a range, there is predictability in both the scenario; the difference is notional as in a range, one looks at the upper end. Unpredictability arises when things such as DSPs/EBRs are done outside FRBM framework; sadly, those are swept under the carpet.
Another argument in support of range is what some experts describe as reinforcing “counter-cyclical” objectives. Put simply, when the economy is on a downswing then, the government needs to undertake major investment to rein in the slide and put the economy back on growth trajectory. It is primarily to tackle extraordinary situations such as during the current year that 0.5% cushion is permitted as per 2018-19 amendment to FRBM Act.
To conclude, incorporation of FD range does not offer anything better than what is already there in the FRBM law i.e. fixed number FD target plus ‘escape clause’ unless it is the intent of mandarins in the finance ministry to have both viz. range as well as the ‘escape clause’; that would be disingenuous. The Finance Commission should refrain from going for a range-bound FD. The extant arrangement should continue with suitable increase in the permissible breach under the ‘escape clause’. All hidden slippages such as DSPs and EBRs should be prohibited.