How FRBM works in India
Check to deficit!!?
WHETHER the fiscal deficit is too high or not is a matter on which economists in India may isagree, but supporters as well as opponents of fiscal conservatism tend to view the Fiscal Responsibility and Budget Management (FRBM) Act 2003 as a curb on large deficits. The Act came into effect on July 5, following the issue by the Finance Ministry of the notification and the FRBM Rules 2004 made under the Act. This article looks at the likely impact of the new law.
What the Act requires
The FRBM Act has four main requirements. First, it requires the Government to place before Parliament three statements each year along with the Budget, covering Medium Term Fiscal Policy, Fiscal Policy Strategy and Macroeconomic Framework. The content is prescribed in the Act and the format in the Rules. Second, the Act lays down fiscal management principles, making it incumbent on the Centre to "reduce the fiscal deficit" (no target is mentioned in the Act, but the Rules prescribe 3 per cent of GDP) and, more categorically, to "eliminate revenue deficit" by March 31, 2008. It requires the Government to set a ceiling on guarantees (the Rules prescribe 0.5 per cent of GDP). The Act provides that the ceilings may be exceeded on grounds of "national security or national calamity or such other exceptional grounds as the Central Government may specify". Third, in its most stringent provision, the Act prohibits the Centre from borrowing from the Reserve Bank of India â€” that is, it bans `deficit financing' through money creation. The RBI is also barred from subscribing to primary issues of Central Government securities. Temporary Ways and Means advances to tide over cash flow problems are permitted. This provision will not apply till April 2006. Exceptions are also allowed whenever the Government declares an exceptional situation, as mentioned earlier. Fourth, the Finance Minister is required to keep Parliament informed through quarterly reviews on the implementation, and to take corrective measures if the reviews show deviations. The Act provides that no deviation shall be permissible "without the approval of Parliament".
An Act and Rules to bind the Centre
The FRBM Act is unusual. Acts of Parliament are usually directed at prescribing the law to be followed by the public or a class of persons or by the government in its dealings with others â€” either the public at large or a section of it. This Act, on the other hand, is aimed solely at fettering the Centre itself from doing things that Parliament does not want it to do. No party other than the government itself is legally bound by the Act. The Rules are even more unusual; the Centre is to issue them in order to constrain itself. How effective is such a legislative curb? Insofar as the Rules are concerned, their legal effect is largely cosmetic. The Government can itself amend them. If the 3 per cent fiscal deficit target is found unrealistic, a notification from the Finance Ministry can change it to 4 per cent or indeed any other figure. The only legal restriction may be that as the Act uses the word `reduce', a target which is higher than the level of deficit in the year the Act was passed may be ultra vires. If more guarantees are to be issued, the target can be raised to any desired level. The portion of the Act dealing with placing of statements before Parliament is hardly something that will cause any difficulties. Portions of the Economic Survey and the Budget Speech will suffice to prepare all three of the new statements. The one firm target in the Act is the (welcome and uncontroversial) aim of eliminating the revenue deficit by 2008. This target can however be relaxed, by none other than...