FRBM panel sets 2.5% fiscal deficit target by FY23

Panel has provided for 'escape clauses' for deviations in fiscal deficit up to 0.5%

A Fiscal Responsibility and Budget Management (FRBM) panel has recommended a fiscal deficit target of 2.5 per cent of the gross domestic product (GDP), revenue deficit of 0.8 per cent and a combined Centre-state debt ceiling of 60 per cent for fiscal year 2022-23, the end point of its six-year medium-term fiscal road map. 

These and other recommendations form part of the draft debt management and fiscal responsibility Bill, which, if accepted by the Narendra Modi government, will replace the existing FRBM Act.

With an aim to provide flexibility to policymakers within the fiscal framework, the panel, headed by former Member of Parliament and Revenue and Expenditure Secretary N K Singh, has suggested a steady target of three per cent from FY18 to FY10 and has also recommended certain strict ‘escape clauses’ which will allow the government deviate from the fiscal road map by 0.5 per cent for any given year.

The panel, whose rather comprehensive report was made public on Friday, also suggested the setting up of a ‘fiscal council’, an independent body which will be tasked with monitoring the government’s fiscal announcements for any given year, providing its own forecasts and analysis for the same as well as advise the finance ministry on triggering the escape clauses.

“The maxim ‘you cannot spend your way to prosperity’ is now widely accepted. Fiscal policies must, therefore, be embedded in caution rather than exuberance; in restraint than profligacy,” the committee stated in the opening lines of its report.

“The committee recommends a path of medium-term consolidation, where the fiscal deficit is envisaged to be on a glide path, to be reduced to 2.5 per cent of the GDP, consistent with reducing the Centre’s debt to 40 per cent by FY23,” the panel said. For the states, it envisages a combined debt at 20 per cent of the GDP.

The panel’s report also contains a lengthy note of dissent from panel member and Chief Economic Advisor Arvind Subramanian, which states that the focus of policymakers should be on reducing primary deficit rather than fiscal deficit. In what could be a first, the other members of the panel have authored a rejoinder to Subramanian’s note.

The other members of the panel are former finance secretary Sumit Bose, Reserve Bank of India (RBI) Governor Urjit Patel, and Rathin Roy, director of the National Institute of Public Finance and Policy. The panel had submitted its report to Finance Minister Arun Jaitley before the 2017-18 Union Budget.

“The FRBM Committee has had detailed discussions with experts and shareholders. We have put the report out for feedback and consultation from public,” Finance Secretary Ashok Lavasa told reporters. “We will examine the recommendations and take a decision,” Lavasa said and added that repealing the existing FRBM Act and replacing it with the new proposed law is an option the Centre would consider.

“Next-generation frameworks are characterised by institutional development and some degree of fiscal flexibility to respond to shocks. The latter is incorporated under an escape clause wherein temporary and moderate deviations from the baseline fiscal path are permitted under exceptional circumstances and in reaction to external shocks,” the panel said, justifying its recommendation of escape clauses.

To ensure these escape clauses are not misused by the government of the day, the panel said they have been defined very narrowly and specifically, unlike the existing FRBM Act wherein the definition of “exceptional circumstance” is defined very opaquely and is liable to misuse. 

The escape clauses are proposed for overriding consideration of national security like acts of war, calamities of national proportion and collapse of agriculture severely affecting farm output and incomes. They are also proposed for “far-reaching structural reforms in the economy with unanticipated fiscal implications” and if a sharp decline occurs in real output growth of at least three percentage points below the average for four preceding quarters.

 “The deviation from the stipulated fiscal deficit target shall not exceed 0.5 percentage points in a year,” the panel said and added that RBI chief Patel is in favour of 0.3 percentage points. 

According to the panel’s recommendations, the escape clauses can be invoked by the Centre after formal consultations and advice of the fiscal council and provided it is accompanied by a clear commitment to return to the original fiscal target in the ensuing fiscal year.

One of the original terms of reference given to the panel was to examine the feasibility of a fiscal deficit range. That has been rejected by the panel as most major economies do not have such a provision and that flexibility has been provided in terms of escape clauses and holding of the deficit target at three per cent for three consecutive years.