Analyzing India’s Fiscal Legislation: FRBM Act, Off-Budget Liabilities, and Debt Sustainability

Session Report
Christeena Sabu

The IMPRI Impact and Policy Research Institute, New Delhi conducted an online spring school program, a one-month immersive introductory certificate training course, Fundamentals of Public Policy – Cohort 2: Awareness of Policies & Governance.

The training course aimed to equip participants with the knowledge and tools needed to comprehend the intricate landscape of public policy, including its justifications, limitations, and various aspects. Led by distinguished experts, it provided a well-rounded understanding of the rudiments of public policy.

On Day 3 of the Fundamentals of Public Policy – Cohort 2: Awareness of Policies & Governance course by Dr. Radhka Pandey ji, delivered a compelling presentation concerning India’s fiscal policy issues which involved Fiscal legislation, off-budget liabilities, debt sustainability, and cost of debt.

Fiscal legislation

Before getting into Fiscal legislation, she underlined certain conceptual foundations governing India’s fiscal policy, such as the fiscal policy framework governed by the Fiscal Responsibility and Budget Management Act (FRBM 2003), and fiscal indicators, such as the fiscal deficit and the primary deficit.

She introduced the concept of Effective Revenue deficit, which is the difference between revenue receipts and grants-in-aid for creating capital assets. It used to be one of the targets of fiscal policy.

Through her presentation, she displayed ‘Budget at the glance’ to get a brief overview of the Interim budget for the year 2024.

Any pitfalls in the FRBM legislation structure have implications for the performance of India’s fiscal policy.

 In this section, the FRBM Act was delved deeper into. The provision is embedded in Article 292 of the Constitution of India, which allows the Union to borrow against the security of the Consolidated Fund of India within the limits, if any, fixed by Parliament from time to time by law.

But surprisingly till 2004, there was no legal framework for determining the government’s borrowing. The government used RBI through the issue of treasury bills in an ad-hoc manner or through the issue of ways and means to overcome short-term liquidity constraints.

This led to the automatic monetization of the fiscal deficit, resulting in the creation of an equivalent amount of money supply, which, in turn, will lead to higher inflation. 

She then dived into the reason for the establishment of the FRBM, the steep surge in the fiscal deficit in the late 90s resulting in the establishment of a committee to draft legislation on fiscal policy chaired by EAS Sharma. It laid down targets for fiscal deficit and borrowings and an escape clause which meant under what condition the central government could deviate from the stated targets of fiscal deficit. It also proposed a Fiscal Management Review Committee (FMRC) to conduct ex-post reviews on government budgets

The other key features and targets of the FRBM Act 2003 were also discussed by Dr. Radhika Ji. She further added that the major issue concerning India’s fiscal policy framework is that FRBM legislation needs to be amended, to bring about the goal post of achieving a fiscal deficit target of 3%.

From 2008-09 to 2012-13, the act was suspended by the then Finance Minister on the grounds India was facing a global financial crisis and could not focus on targets but on stimulating the economy and bringing it out of the low growth phase. Furthermore, she also discussed how the targets were postponed in 2016-17 and 2017-18 without making any amendments to the legislation.

To fit the changing economy, the FRBM legislation recommended a shift from public debt to GDP ratio as a medium-term anchor for fiscal policy since amongst the major peer economies, India had one of the highest public debt to GDP ratios in 2018.

She painted a picture for the viewers of pre and post-COVID situation of fiscal policies.

The debt trajectory of India suggested by the Finance Commission for the year 2020-26 was also studied.

Off budget liabilities

Dr. Radhika Ji defined off-budget liabilities as extra borrowings to finance the expenditures not captured in the budget. They are not reflected in the annual financial statement’s budget, and their impact is not accounted for in the fiscal deficit. It helps in bypassing the debt and deficit targets fixed in the legislation. 

The CAG report of 2016-17 shows that the central government is increasingly resorting to off-budget financing. It is masking the fiscal deficit to the extent of 2 to 3% or even more than that. She then provided an example to make the concept clearer for the viewers. She even threw light on the oversight of state liabilities. The five southern states (Telangana, Andhra Pradesh, Karnataka, Kerala, and Tamil Nadu) account for 93% of the combined states’ liability.

Sustainable Debt

Dr. Radhika Ji talked about the various conditions when debt is sustainable. The first condition occurs when the nominal growth rate exceeds the nominal interest rate, or when there is a negative interest growth differential. The second condition is that the primary balance should be positive meaning the non-interest expenditure should be lower than the overall receipts. India’s economic survey 2021-22 outlines the conditions for debt sustainability analysis and asserts that India’s debt is sustainable due to its projected growth rate of over 8% and comparatively lower interest rates. She then laid down the thumb rules for a sustainable debt path. The discussion then moved on to the trajectory of Indian debt.

Dr. Radhika expressed concern about the state’s liabilities, especially the high debt-to-GDP ratio in the northeastern states. Many states are struggling to meet the debt-to-GDP ratio targets set by the Finance Commission, with their ratios far exceeding the targets. Dr. Radhika also highlighted the gross and net borrowing rates of states. It was underlined that despite the differences in the borrowing costs among the states, their interest rates were similar. Thus not infusing fiscal discipline among the states.

She concluded the session by providing the key message emerging from the analysis that fiscal imprudence does not translate into higher borrowing costs.

Acknowledgment: This article was posted by Christeena Sabu, a research intern at IMPRI.

Read more at IMPRI:

Locating Policy Approaches to Addressing Gender Based Violence

Unraveling Legal Complexity: Insights into Gender-Based Violence Legislation