Explained | What is FRBM Act?

• To advance rather than defer the desirable goal of fiscal prudence, India,  like several other countries, embarked in the mid-2000s on an ambitious project of fiscal consolidation, adopting fiscal rules aimed at curbing fiscal deficits.

• The most well-known and best-studied part of this project was the Fiscal Responsibility and Budget Management (FRBM) Act, adopted by the Centre in 2003. 

• This Act was mirrored by Fiscal Responsibility Legislations (FRLs) adopted by the states, laws that were no less important than the FRBM, since states account for roughly half the general government deficit.

• The enactment of FRBM Act and FRLs by states paved the way for sub-national fiscal consolidation. 

• Fiscal consolidation describes government policies intended to reduce deficits and accumulation of debt.

What is fiscal deficit?
The fiscal deficit is the difference between the government’s total expenditure and its total receipts (excluding borrowing). In layman’s terms, it corresponds to the borrowings and liabilities of the government. As per the technical definition, fiscal deficit is equal to budgetary deficit plus borrowings and other liabilities of the government.

The enactment of FRBM

• Periods of macroeconomic instability in India have invariably been pre-dated by fiscal adventurism. 

• In the 1980s, for example, the combined fiscal deficit had widened to 8.6 per cent in 1984-85 and breached 9 per cent of GDP in the ensuing years. 

• While there are many explanations for the 1991 crisis, including the breakup of the Soviet Union, the Kuwait war affecting remittance flows, the increase in petroleum prices, an indisputable proximate cause was the unsustainable fiscal deficit in the years preceding the 1991 crisis. 

• Following the crisis, fiscal corrections were made coupled with other sector specific structural reforms. A combination of these macro policies and other reforms stabilised the economy.

• It unleashed the entrepreneurial instincts of the private sector and with progressive dilution of financial sector repression, it enhanced competitive efficiency and our economic performance.

• However, later in the 1990s, fiscal deficits again rose sharply to over 10 per cent. 

• Then, the government introduced the Fiscal Responsibility and Budget Management Bill in Parliament.

• The FRBM Act enacted by the Parliament, received the President’s assent in August 2003, and FRBM rules framed under section 8 of the Act, came into force in July 2004.

• The Act aims to make the central government responsible for ensuring inter-generational equity in fiscal management and long-term macroeconomic stability by removing fiscal impediments in the effective conduct of monetary policy and prudential debt management consistent with fiscal sustainability.

• The FRBM Act mandated that the central government limit its fiscal deficit to 3 per cent of the gross domestic product (GDP).

• The Comptroller and Auditor General of India (CAG) was entrusted with the responsibility of periodically reviewing the compliance of the provisions of the FRBM Act and presenting such reviews before both the Houses of Parliament.

• It was felt that instead of corrections through executive action, adherence to fiscal norms were more likely if they were embedded in a legal framework.

• Following the enactment of FRBM Act, by the government of India, the states adopted their respective Fiscal Responsibility Legislations (FRLs) with the objective of designing and implementing a rule-based fiscal management system.

• The FRBM Act has since been amended four times — in 2004, 2012, 2015 and 2018.

Highlights of FRLs by state govts

• Fiscal rules facilitate prudent fiscal management by bringing discipline in the conduct of public finances. 

• The FRLs complemented the provision of debt and interest relief to states by the central government.

• Since then the states have followed a series of reforms aimed at improving the sustainability, efficiency, and transparency of their finances.

• The FRBM Act of the Centre and FRLs of the states follow a deficit rule and set a debt-to-GDP ratio target.  

• The implementation of FRLs has incentivised formulation of fiscal policy strategies, creation of Medium-Term Fiscal Plans (MTFPs) and improvement in transparency. 

• The states have amended their FRLs periodically to adapt to changing needs.

• Fiscal rules can be classified into four broad categories, based on the fiscal variables these rules impinge upon. 

They are: 

i) Budget Balance Rules (BBRs) aim at targeting either the overall fiscal balance or the cyclically adjusted fiscal balance. 

ii) Debt rules set ceilings for public debt-to-GDP ratios. 

iii) Expenditure rules restrict total or specific government spending. 

iv) Revenue rules aim to control revenue through taxation limits or by ensuring minimum receipts.

• Internationally accepted fiscal management principles incorporate the features of transparency, stability, responsibility, fairness, and efficiency at their core. 

Transparency ensures clear policy objectives and access to information by the public.

• Stability involves predictable policymaking and some certainty around its economic impact.

• Responsibility emphasises integrity in budget formulation and public finance management.

• Fairness considers financial implications for future generations.

• Efficiency pertains to the effective design and implementation of fiscal policy and asset/liability management.

• Containing the fiscal deficit and revenue deficit within prescribed limits, maintaining the debt stock at a sustainable level, using borrowed funds for productive use and capping guarantees within an indicative ceiling are some of the fiscal management principles adopted by the states’ FRLs. 

• The associated rules also require three documents to be laid before the legislatures at the time of presentation of the state budget.

They are: 

i) Macroeconomic Framework Statement containing an overview of the state economy, an analysis of growth and sectoral composition of GSDP, and an assessment related to state government finances and future prospects.

ii) Medium Term Fiscal Policy (MTFP) Statement, outlining the state government’s fiscal goals and three-year rolling targets, covering revenue-expenditure balance, use of capital receipts for productive assets, and estimated pension liabilities for the next 10 years.

iii) Fiscal Policy Strategy Statement covering the state’s fiscal policies for the upcoming year relating to taxation, expenditure, borrowings and other liabilities. 

The states’ FRLs also entail that the document should highlight:

i) Strategic fiscal priorities

ii) Key fiscal measures

iii) Reasons for any significant deviations in policies related to taxation, subsidies, and expenditures.

iv) An evaluation of current policies against the fiscal management principles. 

Impact of FRLs

• The adoption of FRLs by state governments in the early 2000s contributed to an improvement in their key fiscal parameters. 

• The consolidated gross fiscal deficit (GFD) of the Indian States fell from an average of 4.3 per cent of GDP during the period 1998-99 to 2003-04 to 2.7 per cent of GDP during 2004-05 to 2023-24. 

• Also, the overall debt of the states declined from 31.8 per cent of GDP at end-March 2004 to 28.5 per cent of GDP at end-March 2024.

• However, it remains well above the level of 20 per cent recommended by the Fiscal Responsibility and Budget Management (FRBM) Review Committee (2017). 

• Moreover, large inter-state variation persists, and new pressures are emerging from an increasing subsidy burden. 

• These developments underline the need for deepening fiscal consolidation by the states. 

• After the implementation of FRLs, fiscal reforms by states have mainly aimed at simplification of taxes and prioritisation of expenditure on focused areas at its core. 

• The most noteworthy taxation reform in the post-FRL era has been the introduction of the Goods and Services Tax (GST) which addressed issues such as multiplicity and cascading effect of indirect taxation. 

• The prominent expenditure reforms include shift from the Old Pension Scheme (OPS) to the National Pension System (NPS); move towards Direct Benefit Transfers (DBT); and implementation of a Single Nodal Agency (SNA) for Centrally Sponsored Schemes. 

• Rapid changes in the economic and geopolitical environment warrant further refinements in states’ fiscal frameworks.