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If the FD range gets embedded in the FRBM Act, it will give sanction to slippages. It will defeat the purpose of fixing a target, which is to obligate the Govt to keep expenses in check

The Finance Ministry is building pressure on the 15th Finance Commission (15th FC) to allow greater flexibility while fixing the fiscal deficit (FD). It wants to adopt a flexible, range-bound FD target instead of a fixed number. With this aim in mind, the Modi Government is reviewing the Fiscal Responsibility and Budget Management (FRBM) Act. The issue was discussed at the Economic Advisory Council (EAC) of the 15th FC, wherein the chairman, NK Singh, cited a similar practice followed by the Reserve Bank of India’s (RBI) with +/- two per cent inflation target while deciding its monetary policy. The immediate prompt for this is the sharp contraction in the Gross Domestic Product (GDP) by about 24 per cent in the first quarter of the current financial year (FY) and a corresponding steep reduction in tax collections even as the expenditure commitments are on the upswing (courtesy the two stimuli already given). As a result, on May 8, the Government raised its gross market borrowing target for the FY 2020-21 to Rs 12,00,000 crore, up from the Rs 7,80,000 crore provided for in the Budget on February 1.

  Of this, the Government had already borrowed Rs 7,66,000 crore during the first half of the current FY and plans to borrow the remaining Rs 4,34,000 crore by January 2021. At Rs 12,00,000 crore, the borrowing limit is already set at about 5.8 per cent of the GDP — 2.3 per cent higher than the budgeted FD target of 3.5 per cent. With this and demand for yet another Stimulus III gaining ground, it is not surprising that the Finance Ministry is building pressure on the 15th FC. During the current year, we have an extraordinary situation, 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 Jaitley had announced the Government’s intent to review the FRBM Act (2003) with a view to make the target flexible (that the announcement was made following the year 2015-16, when it had achieved the FD target of 3.9 per cent, sounds a bit anomalous). He had set up  a committee under NK Singh (it included among others, the then Chief Economic Adviser, Arvind Subramanian, and the 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 FD target of 2.5 per cent, revenue deficit 0.8 per cent, combined Centre-State debt ceiling of 60 per cent and a Central debt ceiling of 40 per cent for 2022-23. Further, it fixed three per cent FD to be achieved during 2018-19. It also allowed the Government to breach the target — by up to 0.5 per cent — 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 three per cent FD by 2020-21 instead of 2018-19 mooted by the committee. Further, it set the debt limit of 40 per cent 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 per cent and seeing no hope of achieving three per cent during 2018-19 as recommended by the committee. While presenting Budget 2020-21, Sitharaman has already invoked the escape clause of the FRBM Act to relax the FD targets for FY 2019-20 from 3.3 per cent Budget Estimate (BE) to 3.8 per cent in the Revised Estimate (RE) and for FY 2020-21, from three per cent as per the glide path required under the Act to 3.5 per cent. The one big thing that she did last year was reducing the Corporate Tax rate, which meant a revenue loss of close to Rs 1,50,000 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 the FD 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, the FD for 2017-18 and 2018-19 would be about 5.9 per cent and 5.7 per cent respectively. For 2019-20, including DSPs alone, FD would be 5.1 per cent. Add EBRs and the deficit will gallop. For 2020-21, the likely deficit of 5.8 per cent is exclusive of DSPs and EBRs.

There is a short provision in the Budget: Food subsidy about Rs 1,03,000 crore and fertiliser subsidy around Rs 80,000 crore. Plus, there will be a huge shortfall in proceeds from disinvestment by at least Rs 1,50,000 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 two per cent, taking the total to 7.8 per cent. Including EBRs, the FD could touch 10 per cent.  Already, under the existing dispensation of FD being a fixed number, the Government has 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, the actual FD was six per cent against the target of three per cent as per the FRBM Act, 2003). On the not so explicit side, DSPs and EBRs have been used to camouflage the true deficit.        

If the FD range gets embedded in the FRBM Act, this will amount to giving legal sanction to slippages. It will defeat the very purpose of fixing a target which is to obligate the Government to keep the excess of its expenses over revenue within a specified limit. The moment the law itself prescribes a range, say of three per cent-3.5 per cent, even the most discerning Government will take the higher end of the range as the benchmark as from a legal standpoint, violation will happen only when the actual exceeds 3.5 per cent.

To put it differently, providing for a range is a more subtle and sophisticated way of embedding in the legislation a more relaxed target without catching the attention of the not so discerning eye.     

The comparison with inflation targeting under the monetary policy to justify FDI range is not all fours. While, the FD target has a direct bearing on budgeting by the Centre (a swing of 0.1 per cent either way makes a difference of Rs 20,000 crore in its borrowing limit), inflation targeting by the 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 an NPA. That is a fixed number, say 25 per cent (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 programme and the resultant impact on crucial parameters like bond yields, interest rate; 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 scenarios. 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 the 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 the growth trajectory. It is primarily to tackle extraordinary situations such as during the current year that a 0.5 per cent cushion is permitted as per the 2018-19 amendment to the FRBM Act.     

The 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, namely range as well as the escape clause. That would be disingenuous. The 15th FC 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.

(The writer is a policy analyst)

Stay within limits

Stay within limits

If the FD range gets embedded in the FRBM Act, it will give sanction to slippages. It will defeat the purpose of fixing a target, which is to obligate the Govt to keep expenses in check

The Finance Ministry is building pressure on the 15th Finance Commission (15th FC) to allow greater flexibility while fixing the fiscal deficit (FD). It wants to adopt a flexible, range-bound FD target instead of a fixed number. With this aim in mind, the Modi Government is reviewing the Fiscal Responsibility and Budget Management (FRBM) Act. The issue was discussed at the Economic Advisory Council (EAC) of the 15th FC, wherein the chairman, NK Singh, cited a similar practice followed by the Reserve Bank of India’s (RBI) with +/- two per cent inflation target while deciding its monetary policy. The immediate prompt for this is the sharp contraction in the Gross Domestic Product (GDP) by about 24 per cent in the first quarter of the current financial year (FY) and a corresponding steep reduction in tax collections even as the expenditure commitments are on the upswing (courtesy the two stimuli already given). As a result, on May 8, the Government raised its gross market borrowing target for the FY 2020-21 to Rs 12,00,000 crore, up from the Rs 7,80,000 crore provided for in the Budget on February 1.

  Of this, the Government had already borrowed Rs 7,66,000 crore during the first half of the current FY and plans to borrow the remaining Rs 4,34,000 crore by January 2021. At Rs 12,00,000 crore, the borrowing limit is already set at about 5.8 per cent of the GDP — 2.3 per cent higher than the budgeted FD target of 3.5 per cent. With this and demand for yet another Stimulus III gaining ground, it is not surprising that the Finance Ministry is building pressure on the 15th FC. During the current year, we have an extraordinary situation, 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 Jaitley had announced the Government’s intent to review the FRBM Act (2003) with a view to make the target flexible (that the announcement was made following the year 2015-16, when it had achieved the FD target of 3.9 per cent, sounds a bit anomalous). He had set up  a committee under NK Singh (it included among others, the then Chief Economic Adviser, Arvind Subramanian, and the 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 FD target of 2.5 per cent, revenue deficit 0.8 per cent, combined Centre-State debt ceiling of 60 per cent and a Central debt ceiling of 40 per cent for 2022-23. Further, it fixed three per cent FD to be achieved during 2018-19. It also allowed the Government to breach the target — by up to 0.5 per cent — 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 three per cent FD by 2020-21 instead of 2018-19 mooted by the committee. Further, it set the debt limit of 40 per cent 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 per cent and seeing no hope of achieving three per cent during 2018-19 as recommended by the committee. While presenting Budget 2020-21, Sitharaman has already invoked the escape clause of the FRBM Act to relax the FD targets for FY 2019-20 from 3.3 per cent Budget Estimate (BE) to 3.8 per cent in the Revised Estimate (RE) and for FY 2020-21, from three per cent as per the glide path required under the Act to 3.5 per cent. The one big thing that she did last year was reducing the Corporate Tax rate, which meant a revenue loss of close to Rs 1,50,000 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 the FD 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, the FD for 2017-18 and 2018-19 would be about 5.9 per cent and 5.7 per cent respectively. For 2019-20, including DSPs alone, FD would be 5.1 per cent. Add EBRs and the deficit will gallop. For 2020-21, the likely deficit of 5.8 per cent is exclusive of DSPs and EBRs.

There is a short provision in the Budget: Food subsidy about Rs 1,03,000 crore and fertiliser subsidy around Rs 80,000 crore. Plus, there will be a huge shortfall in proceeds from disinvestment by at least Rs 1,50,000 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 two per cent, taking the total to 7.8 per cent. Including EBRs, the FD could touch 10 per cent.  Already, under the existing dispensation of FD being a fixed number, the Government has 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, the actual FD was six per cent against the target of three per cent as per the FRBM Act, 2003). On the not so explicit side, DSPs and EBRs have been used to camouflage the true deficit.        

If the FD range gets embedded in the FRBM Act, this will amount to giving legal sanction to slippages. It will defeat the very purpose of fixing a target which is to obligate the Government to keep the excess of its expenses over revenue within a specified limit. The moment the law itself prescribes a range, say of three per cent-3.5 per cent, even the most discerning Government will take the higher end of the range as the benchmark as from a legal standpoint, violation will happen only when the actual exceeds 3.5 per cent.

To put it differently, providing for a range is a more subtle and sophisticated way of embedding in the legislation a more relaxed target without catching the attention of the not so discerning eye.     

The comparison with inflation targeting under the monetary policy to justify FDI range is not all fours. While, the FD target has a direct bearing on budgeting by the Centre (a swing of 0.1 per cent either way makes a difference of Rs 20,000 crore in its borrowing limit), inflation targeting by the 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 an NPA. That is a fixed number, say 25 per cent (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 programme and the resultant impact on crucial parameters like bond yields, interest rate; 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 scenarios. 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 the 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 the growth trajectory. It is primarily to tackle extraordinary situations such as during the current year that a 0.5 per cent cushion is permitted as per the 2018-19 amendment to the FRBM Act.     

The 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, namely range as well as the escape clause. That would be disingenuous. The 15th FC 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.

(The writer is a policy analyst)

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