The Hindu : Fiscal legislation as a tool for fiscal reform

Online edition of India's National Newspaper
Monday, Jun 23, 2003

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Fiscal legislation as a tool for fiscal reform

THE FISCAL Responsibility and Budget Management Bill, 2000 (FRBM) was introduced in Parliament in December 2000. The Lok Sabha passed it on May 7 this year. Introduction of the bill was generally welcomed with some reservations on specific clauses. It signified the Central Government's recognition of the seriousness of the fiscal drift that has been taking place in recent years.

The bill was the first attempt to liberate fiscal policy and management from short term political compulsions through a fiscal law. There were high expectations that this would send a clear message about fiscal discipline and rectitude to politicians, ministers, civil servants and the public. However, the bill was diluted drastically in the light of the recommendations of the parliamentary committee that examined it.

Changes made in the bill

The main features of the original bill were the quantitative time bound targets for budget deficits, a cap on government borrowings, abolition of direct borrowings from the Reserve Bank of India and a limit on guarantees given by the Government. The revised bill omits the phased deficit targets and leaves it to the rules to set annual targets. The scope for flexibility to deviate from norms has been expanded to include exceptional circumstances as the Centre may specify in addition to national calamities and national security provided in the earlier bill. A new clause gives immunity from civil courts for any decision or action taken by the Government under the Act.

Prima facie it may appear that the watered down bill will not serve any purpose. A careful analysis, however, shows that such scepticism is not warranted.

The deletion of targets in the final bill is by itself not a matter for lament as these were anyway seriously flawed. They merely indicated elimination of revenue deficit in five years and reduction of fiscal deficit to 2 per cent of GDP by the end of the same period. There was no clue as to how this was to be achieved. Projections of revenue and expenditure with underlying assumptions were not available. Nor was there any clue of strategies to realise fiscal consolidation. This raised doubts whether the deficits were to be reduced by cutting development and capital expenditure.

An important question left unanswered was whether deficit control would override growth and development. Would the cure be worse than the disease? One cannot escape the impression that the numerical targets in the original bill were hastily put together and did not address fundamental issues of revenue mobilisation and expenditure policy and management.

Permitting deviation from targets in `exceptional circumstances' to be specified by the Government is also not without merit. A serious misgiving in the original bill was about the rigidity imposed on fiscal operation. Deviations from targets were permitted only in times of national security or national (natural?) calamity. Cyclical fluctuations in the economy were not visualised as a possible reason for temporary deviation. This was a serious shortcoming cutting the very ground under sound fiscal policy to meet changing economic scenarios.

Immunity from courts for action taken under the legislation need not also be a matter of concern. The courts do not have the expertise to question fiscal policy matters or suggest timely alternative solutions. It is not a bad idea to leave these issues outside the purview of Public Interest Litigation.

Framing of rules

Relegation of targeting to rules gives another opportunity for the Government to make the legislation purposeful with more credible targets. A lot of homework needs to be done in framing the rules. Here are some suggestions:

Present the annual deficit targets against a backdrop of at least three year projections of revenue and expenditure. Make explicit the macro economic and other assumptions on which the targets and three year projections are made. Targets based on realistic assumptions and estimates will enhance credibility and compliance.

Spell out the fiscal objectives and fiscal strategies to achieve these. Explain how deficit elimination/reduction will contribute to sustainable development. In particular, quantify the anticipated savings in unnecessary and non-development expenditure and highlight revised sectoral priorities and allocations in favour of growth and development. It will increase the credibility of targets if the Government can link these to action to address vital issues of fiscal policy and management such as limiting the Government's role to that of a facilitator, steps to reduce the cost of providing services and goods, freeing government budgets from the task of propping up public sector undertakings and the Railways along with vigorous privatisation and using the proceeds to retire public debt. On the revenue side, the projections should be shown to reflect action to expand the revenue base — tax and non-tax — and steps to collect mounting dues to the Government. Identify the major risk factors and frame realistic estimates and targets. Recourse to the exceptional circumstances clause for deviating from targets should be in rare cases that cannot be anticipated and not used to cover up inaccurate or slipshod budgeting. And such deviations should be temporary and with a plan to revert to normality as soon as possible.

Follow up action

Careful framing of rules and targets is only the first step in fiscal reconstruction. The follow up action needed is indicated here:

Sensitise ministers, legislators, civil servants and the public on the rationale of the new law.

Initiate and sustain reform in related areas such as improvement in budgeting and cash management, stricter accountability for output and outcome from expenditure besides financial rectitude, better project management and stricter control, and transparency in contingent liabilities. In fact such a law was the culmination of a decade of wide ranging public sector reform in New Zealand that included a law to confer more autonomy to their central bank for an independent monetary policy as a complement (or antidote) to fiscal policy.

Strengthen the Finance Ministry and form a special standing cell to oversee the reform.

Convene a meeting of finance ministers of States to ensure coordinated approach in achieving fiscal consolidation.

A. Rangachari

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