What were the reasons for the introduction of Fiscal Responsibility and Budget Management (FRBM) Act, 2003? What were the shortcomings in the Act that undermined its effectiveness? (10 marks)

 

Approach:

  • Briefly discuss FRBM in the introduction
  • Explain the need of FRBM act
  • Discuss the various shortcomings in the Act that made it less effective
  • Conclude with suggestions of N.K. Singh Committee
Model Answer :

The Fiscal Responsibility and Budget Management Act, 2003 (FRBM) was an Act of the Parliament of India to institutionalize financial discipline, reduce India’s fiscal deficit, and improve macroeconomic management and the overall management of the public funds by moving towards a balanced budget.

Reasons for the introduction of FRBM Act:

  • High revenue deficit due to higher expenditure on subsidies, salaries, defence etc. forced the government to make big borrowing from early 1990s onwards.
  • The borrowing again produced high interest payments. The interest payments became the largest expenditure item of the government.
  • The rising government borrowing and high interest payments seriously eroded the financial health of the government. The high fiscal deficit not only threatened financial stability of the nation but also raised the risk of credit default and possible downgrade by credit rating agencies.
  • This can be seen by the high fiscal deficit of centre and states at that time, with central deficit over 6% and combined states and centre deficit over 8%.

Thus to institutionalize fiscal prudence and discipline, FRBM was enacted. FRMB Act aimed to achieve fiscal discipline through limits on the Central Government borrowings, debt and deficits, greater transparency in fiscal operations of the Central Government etc.

Why ineffective?

While there were some early successes, the targets mostly went unmet and were revised several times. Over the last few years, the government of India again paid greater attention to fiscal responsibility, and announced in the budget 2016-17 its decision to gradually realize the 3% fiscal deficit target, as originally set.

Shortcomings in the FRBM Act:

  • The Act prescribes a target fiscal deficit of 3% of GDP for the centre but with no explicit justification for the number. The limits set have been mostly violated.
  • There is no flexibility in the Act to deal with cyclical shocks like financial crisis of 2008.
  • There is no mechanism like fiscal accountability council to review fiscal performances under the act.
  • As the 14th Finance Commission has mandated greater devolution of taxes to the states, changes are required in terms of apportioning the debt between centre and states.
  • FRBM act is outdated as it was passed in 2003 which some say is not suitable in present context.

FRBM brought focus on fiscal discipline and provided benchmarks to measure the same. However, there is a need for fiscal management, including FRBM, to evolve to the changing needs to the time. The recommendations of the N.K Singh committee on flexible targets with escape clause, creation of fiscal council, focus on reduction of combined debt-to-GDP ratio of the centre and states to 60 per cent by 2023 etc. may be incorporated.

Subjects : Economy

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