9/19/2017 Fiscal Responsibility and Budget Management (FRBM) Act - Arthapedia

Fiscal Responsibility and Budget Management

(FRBM) Act
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Fiscal Responsibility and Budget Management (http://finmin.nic.in/law/frbmact2003.pdf) (FRBM) became an

Act in 2003. The objective of the Act is to ensure inter-generational equity in fiscal management, long run
macroeconomic stability, better coordination between fiscal and monetary policy, and transparency in fiscal
operation of the Government.

The Government notified FRBM rules in July 2004 to specify the annual reduction targets for fiscal indicators.
The FRBM rule specifies reduction of fiscal deficit to 3% of the GDP by 2008-09 with annual reduction target
of 0.3% of GDP per year by the Central government. Similarly, revenue deficit has to be reduced by 0.5% of
the GDP per year with complete elimination to be achieved by 2008-09. It is the responsibility of the
government to adhere to these targets. The Finance Minister has to explain the reasons and suggest corrective
actions to be taken, in case of breach.

FRBM Act provides a legal institutional framework for fiscal consolidation. It is now mandatory for the Central
government to take measures to reduce fiscal deficit, to eliminate revenue deficit and to generate revenue
surplus in the subsequent years. The Act binds not only the present government but also the future Government
to adhere to the path of fiscal consolidation. The Government can move away from the path of fiscal
consolidation only in case of natural calamity, national security and other exceptional grounds which Central
Government may specify.

Further, the Act prohibits borrowing by the government from the Reserve Bank of India, thereby, making
monetary policy independent of fiscal policy. The Act bans the purchase of primary issues of the Central
Government securities by the RBI after 2006, preventing monetization of government deficit. The Act also
requires the government to lay before the parliament three policy statements in each financial year namely
Medium Term Fiscal Policy Statement; Fiscal Policy Strategy Statement and Macroeconomic Framework
Policy Statement.

To impart fiscal discipline at the state level, the Twelfth Finance Commission gave incentives to states through
conditional debt restructuring and interest rate relief for introducing Fiscal Responsibility Legislations (FRLs).
All the states have implemented their own FRLs.

Background

Indian economy faced with the problem of large fiscal deficit and its monetization spilled over to external
sector in the late 1980s and early 1990s. The large borrowings of the government led to such a precarious
situation that government was unable to pay even for two weeks of imports resulting in economic crisis of
1991. Consequently, Economic reforms were introduced in 1991 and fiscal consolidation emerged as one of the
key areas of reforms. After a good start in the early nineties, the fiscal consolidation faltered after 1997-98. The
fiscal deficit started rising after 1997-98. The Government introduced FRBM Act,2003 to check the
deteriorating fiscal situation.

Implementation

The implementation of FRBM Act/FRLs improved the fiscal performance of both centre and states. The States
have achieved the targets much ahead the prescribed timeline. Government of India was on the path of
achieving this objective right in time. However, due to the global financial crisis, this was suspended and the
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fiscal consolidation as mandated in the FRBM Act was put on hold in 2007-08.The crisis period called for
increase in expenditure by the government to boost demand in the economy. As a result of fiscal stimulus, the
government has moved away from the path of fiscal consolidation. However, it should be noted that strict
adherence to the path of fiscal consolidation during pre crisis period created enough fiscal space for pursuing
counter cyclical fiscal policy.

Amendments to FRBM Act

Through Finance Act 2012, amendments were made to the Fiscal Responsibility and Budget Management Act,
2003 through which it was decided that in addition to the existing three documents, Central Government shall
lay another document - the Medium Term Expenditure Framework Statement (MTEF)
(http://www.arthapedia.in/index.php?title=Medium-term_Expenditure_Framework_(MTEF)_Statement) -
before both Houses of Parliament in the Session immediately following the Session of Parliament in which
Medium-Term Fiscal Policy Statement (http://www.arthapedia.in/index.php?title=Medium-
term_Fiscal_Policy_(MTFP)_Statement) , Fiscal Policy Strategy Statement
(http://www.arthapedia.in/index.php?title=Fiscal_Policy_Strategy_Statement) and Macroeconomic Framework
Statement (http://www.arthapedia.in/index.php?title=Macro-economic_Framework_Statement) are laid.

Amendments to the FRBM Act were introduced subsequent to the recommendations of 13th Finance
Commission (http://fincomindia.nic.in/ShowContentOne.aspx?id=28&Section=1) .

Concept of “Effective Revenue Deficit” and “Medium Term Expenditure Framework” statement are the two
important features of amendment to FRBM Act in the direction of expenditure reforms. Effective Revenue
Deficit is the difference between revenue deficit and grants for creation of capital assets. This will help in
reducing consumptive component of revenue deficit and create space for increased capital spending. Effective
revenue deficit has now become a new fiscal parameter. “Medium-term Expenditure Framework” statement
will set forth a three-year rolling target for expenditure indicators.

As per the amendments in 2012, the Central Government has to take appropriate measures to reduce the fiscal
deficit, revenue deficit and effective revenue deficit to eliminate the effective revenue deficit by the 31st
March, 2015 and thereafter build up adequate effective revenue surplus and also to reach revenue deficit of not
more than 2 % of Gross Domestic Product by the 31st March, 2015 and thereafter as may be prescribed by
rules made by the Central Government.

Further, the Central Government may entrust the Comptroller and Auditor-General of India
(http://www.saiindia.gov.in/english/index.html) to review periodically as required, the compliance of the
provisions of FRBM Act and such reviews shall be laid on the table of both Houses of Parliament.

Vide the Finance Act 2015 (http://indiabudget.nic.in/bill.asp) , the target dates for achieving the prescribed rates
of effective deficit and fiscal deficit were further extended. The effective revenue deficit which had to be
eliminated by March 2015 will now need to be eliminated only after 3 years i.e., by March 2018. The 3% target
of fiscal deficit to be achieved by 2016-17 has now been shifted by one more year to the end of 2017-18.

The Union Cabinet chaired by the Hon’ble Prime Minister on 6 April 2016 gave its approval to
Recommendations on Fiscal Deficit Targets and Additional Fiscal Deficit to States during Fourteenth Finance
Commission (FFC) award period 2015-20 under the two flexibility options recommended in para 14.64 to
14.67 of its Report (volume – I). FFC has adopted the fiscal deficit threshold limit of 3 per cent of Gross State
Domestic Product (GSDP) for the States. Further, FFC has provided a year-to-year flexibility for additional
fiscal deficit to States. FFC, taking into account the development needs and the current macro- economic
requirement, provided additional headroom to a maximum of 0.5 per cent over and above the normal limit of 3
per cent in any given year to the States that have a favourable debt-GSDP ratio (means if debt-GSDP is not
more than 25%, then an additional 0.25% fiscal deficit can be afforded) and interest payments-revenue receipts
ratio (means if IP-RR is not more than 10%, then an additional 0.25% fiscal deficit can be afforded) in the
previous two years. However, the flexibility in availing the additional fiscal deficit will be available to State if
there is no revenue deficit in the year in which borrowing limits are to be fixed and immediately preceding

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year. If a State is not able to fully utilise its sanctioned fiscal deficit of 3 per cent of GSDP in any particular
year during the 2016-17 to 2018-19 of FFC award period, it will have the option of availing this un-utilised
fiscal deficit amount (calculated in rupees) only in the following year but within FFC award period.

Further, the Government of India launched the scheme Ujwal DISCOM Assurance Yojana (UDAY)
(http://pib.nic.in/newsite/PrintRelease.aspx?relid=130261) for the financial and operational turnaround of state-
owned Power Distribution Companies (DISCOMs) in 2015. The scheme aims to reduce interest burden, reduce
the cost of power, reduce power losses in Distribution sector, and improve operational efficiency of DISCOMs.
The scheme also incentivizes the States by exempting State takeover of DISCOM debts from FRBM limits for
two years. [Under UDAY, States shall take over 75% of DISCOM debt as on 30 September 2015 over two
years - 50% of DISCOM debt shall be taken over in 2015-16 and 25% in 2016-17. Government of India will
not include the debt taken over by the States as per the above scheme in the calculation of fiscal deficit of
respective States in the financial years 2015-16 and 2016-17. States will issue bonds in the market or directly to
the respective banks / Financial Institutions (FIs) holding the DISCOM debt to the appropriate extent.
DISCOM debt not taken over by the State will be converted by the Banks / FIs into loans or bonds with interest
rate not more than the bank’s base rate plus 0.1%. Alternately, this debt may be fully or partly issued by the
DISCOM as State guaranteed DISCOM bonds at the prevailing market rates which shall be equal to or less
than bank base rate plus 0.1%. Further, States have to take over the future losses of DISCOMs in a graded
manner and shall fund them too.]

N K Singh Committee Review of FRBM

In the Union Budget 2016-17 (http://indiabudget.nic.in/ub2016-17/bs/bs.pdf) it was proposed to constitute a

Committee to review the implementation of the FRBM Act and give its recommendations on the way forward.
This was in view of the new school of thought which believes that instead of fixed numbers as fiscal deficit
targets, it may be better to have a fiscal deficit range as the target, which would give necessary policy space to
the Government to deal with dynamic situations. There is also a suggestion that fiscal expansion or contraction
should be aligned with credit contraction or expansion respectively, in the economy. While remaining
committed to fiscal prudence and consolidation, Budget stated that a time has come to review the working of
the FRBM Act, especially in the context of the uncertainty and volatility which have become the new norms of
global economy.

Government constituted the Committee in May, 2016 under the Chairmanship of Shri N.K. Singh, former
Revenue and Expenditure Secretary and former Member of Parliament. The Committee consisted of Dr. Urjit
R. Patel, Governor, Reserve Bank of India (RBI), Shri Sumit Bose, former Finance Secretary, Dr. Arvind
Subramanian, Chief Economic Adviser and Dr. Rathin Roy, Director, National Institute of Public Finance &
Policy (NIPFP) as members.

The Committee had wide ranging Terms of Reference (ToR) to comprehensively review the existing FRBM
Act in the light of contemporary changes, past outcomes, global economic developments, best international
practices and to recommend the future fiscal framework and roadmap for the country. Subsequently, the Terms
of Reference were enlarged to seek the Committee’s views on certain recommendations of the Fourteenth
Finance Commission and the Expenditure Management Commission. These primarily related to strengthening
the institutional framework on fiscal matters as well as certain issues connected with new capital expenditures
in the budget. Committee submitted its report in January 2017
(http://dea.gov.in/sites/default/files/Volume%201%20FRBM%20Review%20Committee%20Report.pdf) .

References
1. GoI, Chapter 2, Public Finance, Economic Survey, 2003-04, pp-18-44
2. Gazette of India, FRBM Act, 2003, No. 39 of 2003, Ministry of Law and Justice.
3. http://www.financialexpress.com/printer/news/121273/
4. GoI, Chapter-3 , Public Finance, Economic Survey, 2010-11, pp-40-68

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5. Patnaik, P., (2006) What is Wrong With ‘Sound Finance’ Economic and Political Weekly, Nov 4, pp
4560-4564.
6. Simone, A.S. and Petia Topalova (2009), India’s Experience with Fiscal Rules: an Evaluation and the
Way Forward, IMF Working Paper 175, Aug.

Contributed by
Puja Rustagi, IES (2009) (http://www.ies.gov.in/myaccount-profile-view.php?memid=379)
Email- rustagipuja@gmail.com (mailto:rustagipuja@gmail.com)

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