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FRBM Act - Analysis

Post by Admin Oct 08,2018

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FRBM Act - Analysis

Post by Admin,Oct 08,2018.
News

  • After the presentation of the Fiscal Responsibility and Budget Management (FRBM) Act in 2003 and the related FRBM Rules in 2004, the target fiscal deficit to GDP ratio of 3% for the Union government was achieved only once, in 2007-08, when it was 2.5%.
  • The FRBM Act was amended twice, in 2012 and 2015.
  • The revisions in 2015 shifted the date for achieving the 3% target to 2017-18.
  • By this year, the amended revenue deficit target was put at 2% of GDP.

[break]

Resetting the framework
  • Budget 2018-19 has proposed amending the FRBM Act again, which will shift the target of 3% fiscal deficit-GDP ratio to end-March 2021.
  • But on the bench there was no target set for revenue deficit.
  • The new statutory anchors relate to the general and Central government debt-GDP ratios that are to be reduced to 60% and 40% of GDP, respectively, by 2024-25, based on the recommendations of the report by the FRBM Review Committee.
  • Missing the fiscal responsibility targets year after year and changing the statutory framework time and again bring the credibility of the government’s commitment to fiscal discipline in the spotlight.
  • As per the requirement of the FRBM Act of 2003, and amended in 2015, a medium-term fiscal policy statement has been presented by successive governments in each Budget, setting three-year rolling targets for fiscal, revenue, and effective revenue deficits and outstanding debt of the Central government.
  • The average rate or margin by which different governments have reduced the fiscal and revenue deficits relative to GDP has been quite low.
  • The current Budget has retained the fiscal deficit at 3.5% of GDP, missing the budgeted target of 3.2% which was itself a deviation from the stipulated target of 3% for 2017-18 in the amended FRBM Act.
  • A slippage margin of 50 basis points implies a delay in reaching the target by two and a half years given the average margin of reduction of 0.2 percentage points per year.
  • In the absence of improvement in the fiscal deficit level in 2017-18, the debt-GDP ratio has increased to 49.1% in 2017-18 from 48.7% in 2016-17 rather than falling, which was the trend until recently.
Diluting recommendations
  • In the proposed amendment to the FRBM Act, key recommendations of the review committee were not accepted.
  • It had wanted the target at which the fiscal deficit to GDP ratio was to be stabilised set at 2.5%. The government apparently continued with the 3% target.
  • It had specified a revenue deficit glide path, reaching 0.8% by 2022-23. This too was not accepted.
  • The target of revenue account balance is well recognised in the so-called ‘golden rule’ wherein a country may borrow as long as the entire borrowing is spent on capital spending. This can only be achieved by keeping the revenue deficit to zero.
  • In the Indian context, the revenue deficit with some adjustments reflects government dis-savings. Unless government dis-savings are eliminated, it will be difficult to reverse the trend of a falling savings rate.
  • Central government did not accept another recommendation of setting up a fiscal council, which could independently examine the economic case and justification for deviating from the specified targets.
  • Fourth, in the committee’s recommendations, the debt-GDP levels of 60% and 40% of GDP for the general and Central governments, respectively, were to be achieved by 2022-23. These target dates have been shifted to 2024-25.

Budget Deficit

Definition: The Budget Deficit is the financial situation wherein the expenditures exceed the revenues. The Budget Deficit generally relates to the government’s expenditure and not the business or individual’s spending.

 

The government’s collective deficits are termed as “National Debt”. In the case of a budget deficit, be it the Government or any business, it has to resort to the external borrowings in order to escape the bankruptcy. The Investors or analyst study the budget deficit of the country or business to judge its financial health.

There can be different types of budget deficits that can be classified on the basis of types of receipts and expenditures taken into the consideration. These are:

Revenue Deficit

Definition: The Revenue deficit refers to the financial position wherein the government’s revenue expenditure exceeds its total revenue receipts. This means that government’s own earnings are not sufficient to meet the day-to-day functioning of its departments and other provisions of services.

 

The revenue deficit is only concerned with the revenue receipts and the revenue expenditures of the government. Obviously, when the government spends more than what it earns has to resort to the external borrowings, thus the revenue deficit results into the borrowings.

Symbolically, such financial situation can be expressed as:
Revenue Deficit = Total Revenue Expenditures – Total Revenue Receipts

The government can take following remedial actions to overcome this financial situation:

  • The deficit could be met from the capital receipts, i.e. through the borrowings or sale of existing assets.
  • The government could increase its tax or non tax receipts, i.e. a higher tax rate could be levied especially on a rich class people or any new taxes could be imposed wherever possible.
  • The Government should try to curtail its expenses, especially the unnecessary expenditures.

The government’s revenue deficit has several severe implications, which are as follows:

  1. The revenue deficit has to be met from the capital receipts that forces a government to either borrow or sell its existing assets, which results in the reduction of assets.
  2. Since the government uses more of capital receipts to meet its consumption expenditure, leads to the inflationary situation in the economy.
  3. With more and more borrowings, the burden to repay the liability and the interest increases that results into larger revenue deficits in the future.

Note: It is to be taken into prime consideration, that revenue deficit includes only those transactions that have a direct impact on the government’s current income and expenditure.

Fiscal Deficit

Definition: Fiscal Deficit refers to the financial situation wherein the government’s total budget exceeds the total receipts excluding borrowings made during the fiscal year. Thus, it can be expressed as:

 

Fiscal Deficit = Total Expenditure – Total Receipts Excluding Borrowings

Through Fiscal deficit, the government can determine the amount that needs to be borrowed in case it lacks adequate resources.

The fiscal deficit can occur even if the revenue deficit is not there if the following conditions prevail:

  • Revenue budget is balanced, but the capital budget is in deficit.
  • Revenue budget is in the surplus, and the capital budget is in deficit, and the deficit is more than the surplus.

Borrowings are the only way to finance the fiscal deficit, and this results into the following severe implications on the economy::

  1. The fiscal deficit could be financed only through borrowings and with more and more borrowings the debt obligations increases. The government has to repay the loan amount along with the interest that results into the increase in the revenue expenditure and as a result, the revenue deficit increases. Thus, this compels the government to resort to the external borrowings.
  2. The deficit often leads to the wasteful expenditure of the government that ultimately results in the inflationary pressures in the economy. Also, the government issues money from the RBI, that prints more currency, called as deficit financing and with more circulation of money in the economy the inflation persists.
  3. The money borrowed in the form of loan is not fully utilized since the government has to pay a part of it in the form of interest. Thus, the loan remains partly utilized.
  4. With the borrowings and repayment of liability, the growth of the economy slows down in the future.

Thus, the fiscal deficit is the amount of borrowings that government resorts to meet out its requirement and larger the deficit, the larger is the amount of borrowings and vice-versa.

Primary Deficit

Definition: The Primary Deficit is the difference between the fiscal deficit of current year and the interest paid on the previous borrowings. Thus, primary deficits are government’s borrowings exclusive of interest payment.

 

Generally, the loan raised by the government is inclusive of the interest amount, and if that amount is deducted from the principal loan amount, the balance amount is called as the primary deficit. The purpose of measuring such deficit is to know the amount of borrowings that government can utilize in the expenses other than the interest payments.

Symbolically, it can be represented as:

Primary Deficit = Fiscal Deficit – Interest payments on the previous borrowings

In case, the primary deficit is zero; then the fiscal deficit becomes equal to the interest payment, which means government resort to borrowings just to pay off the interest payments. Thus, the low or zero primary deficits indicate that the government was forced to resort to the external borrowings to meet out its previous interest obligations, and nothing gets added to the existing loan.

Monetised Deficit

Definition: The Monetised Deficit is the extent to which the RBI helps the central government in its borrowing programme. In other words, monetised deficit means the increase in the net RBI credit to the central government, such that the monetary needs of the government could be met easily.

The monetized deficit results in the increase in the net holdings of treasury bills by the RBI and also the RBI contribution towards the government’s market borrowings increases. With the issue of more money to the government, the money supply in the economy increases, as a result of which the inflationary pressure prevails. Hence, we can say that monetised deficits are the part of a fiscal deficit that leads to the inflation in the economy.

Thus, it can be concluded that monetised deficit occurs when the government takes a monetary support from the RBI to finance its debt obligations and try to reduce its unnecessary expenditures.

The Budget surplus is opposite of budget deficit where the revenues exceed the expenditures, and when the spending is equal to the revenues, the budget is said to be balanced. The major implications of a Government budget deficit are:

  • Slower economic growth
  • Increased tax revenue
  • High unemployment rates
  • High Government spending
  • Investors expect high inflation rates due to which the real value of debt reduces and thus, the investors expect higher interest rates for their future loans to the government.

Ideally, for any investor the budget deficits are a threat, but he must understand the reasons behind such a deficit. The reason for such a deficit could be the investments made in the infrastructure development or any other profitable investments that will yield profits in the future, could be seen as healthier than the situation, where a country or a business entity is facing a deficit due to unsustainable expenses.