11 December, 2019
Syllabus subtopic: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.
Prelims focus: About fiscal deficit, revenue deficit, primary deficit, FRBM Act
Mains focus: on the impact of fiscal deficit on inflation, and different steps taken by the govt. to check inflation
Context: India’s economic slowdown has led to a severe revenue shortfall in direct and indirect taxes. As expenditure expands while revenue falls short of budgeted expectations, the fiscal deficit will rise.
What exactly is a government deficit?
Government finances are adequately discussed during the budget and at times of slowdown. One such indicator of interest is the deficit of the government. There are three measures of government deficits:
Fiscal deficit is one of the most discussed of the three, as it is the money the government borrows to meet its expenditure.
So, is it bad if the fiscal deficit increases?
A natural inclination is to believe that if the expenditure is greater than the revenue, then it must be a bad thing. Unfortunately, there’s no simple answer to this question. A prolonged fiscal deficit above 4% is likely to be problematic, but there’s little difference between a deficit of 3.5% or 3.8%. More than the amount of fiscal deficit, what really matters is how the borrowed money is being utilized. If it is utilized for the construction of physical infrastructure, then it is not necessarily a bad thing. But if it is used for farm loan waivers or other such subsidies, then a high fiscal deficit should be a cause of major concern.
What is the expected fiscal deficit for FY20?
The budget estimates indicated a fiscal deficit close to 3.3% of GDP that seemed unrealistic given the extent of the current economic slump. The FRBM Act allows a 0.5 percentage point relaxation in deficit in the event of a severe slowdown. This allows the government a fiscal deficit till 3.8% without violating the provisions of the FRBM Act.
How does fiscal deficit impact inflation?
Conventional wisdom has been that fiscal deficits result in undue inflationary pressures. This is based on India’s experience with high deficits in the 1980s and since 2009 onwards, when inflation and fiscal deficits were both high. But an important fact during these two periods was high international prices of global commodities and high minimum support prices for farmers. Moreover, not all deficits are inflationary: if the additional money is utilized for investments rather than subsidies, inflation is likely to be muted.
Can the govt keep on spending as it wants?
Not at all. Though fiscal deficits may not impact inflation, they do impact interest rates—the cost of government borrowings. A higher cost of borrowing constraints government borrowing. In the present situation, the government must respond with a countercyclical fiscal policy. Luckily, that has been the stance of the finance ministry; however, it must share a credible long-term, medium-term fiscal consolidation road map.
FRBM Act – Objectives, targets, Amendments
The fiscal Responsibility and Budget Management Act (FRBM Act) was introduced in Parliament as the FRBM Bill in December 2000. It seeks to foster fiscal discipline on the Central Government and achieve a balanced budget with effective revenue management. The Act was passed on August 26, 2003, therefore it is also called the Fiscal Responsibility and Budget Management Act (FRBMA), 2003. FRBMA was brought into effect on July 5, 2004.
The objective of FRBM Act was to inculcate the habit of fiscal discipline in the governance structure of the country. It sets targets and suggests means of reducing fiscal and revenue deficits.
The targets that were set in original version of act were:
Statements mandated under FRBM Act
The Central government shall lay in each financial year before both houses of Parliament the following statements of fiscal policy along with the annual financial statement and demands for grants:
Section 4 of the FRBM Act, 2003 states that “due to ground or grounds of national security or national calamity or such other exceptional grounds as the Central Government may specify”, the set targets for revenue and fiscal deficit can be exceeded
Amendments in FRBM Act
More than 15 years has passed since FRBM Act was first introduced. But still the government is nowhere near the targets set under the act. The subsequent governments at Centre have amended the act to achieve fiscal prudence. Here are the amendments that have been done in the act so far:
FRBM Review Committee (N.K Singh Committee)
The government formed the committee to review the FRBM Act, 2003 to suggest changes in the act. The committee was headed by Mr. N K Singh (politician, economist and former Indian Administrative Service officer). Recommendations of the committee were:
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