Many states have asked the Centre to raise the fiscal deficit limit from 3 % to 5 %. It must be noted that under the Fiscal Responsibility and Budget Management (FRBM) Act, states are mandated to keep their fiscal deficit under 3% of their respective GSDP.
[You may read: Fiscal Deficit; Revenue Deficit; Primary Deficit]
What is Fiscal Responsibility and Budget Management Act?
The Fiscal Responsibility and Budget Management (FRBM) Act was enacted in the year 2003. It required the Central Government to reduce its fiscal deficit to 3 % of GDP and eliminate revenue deficit by 2009.
[You may read: What is GDP?- Explained]
Therefore, since 2004, the budget of the Union Government includes a medium-term policy statement that specifies the annual revenue and fiscal deficit targets for the next 3 years.
The Government had cut fiscal deficit to 2.7 % of GDP in 2007-08. But, the target had to be suspended in 2008-09 due to the global financial crisis which required additional expenditure by the Government to provide fiscal stimulus to the economy. The fiscal deficit rose to 6.2% in 2008-09. Since then, the Government has never managed to achieve the target of 3 %.
[You may read- Financial Crisis 2007-08 explained]
That said, several states have also enacted similar legislation to institutionalize fiscal responsibility.
The FRBM Act has an ‘escape clause’ which allows the Government to deviate from its fiscal deficit target. [The amendment to the FRMB Act in 2018 defined the escape clause clearly. The FRBM Act, 2003 did not mention the ‘escape clause’ explicitly. It was defined properly in the amendment] It specifies 3 conditions under which it can be invoked:
- There are over-riding considerations of national security acts of war and calamities of national proportion and collapse of agriculture severely affecting farm output and incomes.
- There are far-reaching structural reforms in the economy with unanticipated fiscal implications.
- There is a sharp decline in real output growth of at least 3 percentage points below the average for the previous four quarters.
The FRBM amendment also mentioned that the deviation from the stipulated fiscal deficit target must not exceed 0.5 percentage points in a year.
[In the year 2016, the Government set up a committee under NK Singh to review the FRBM Act. It came up with recommendations. The Union Budget of 2018 amended the FRBM Act through the Finance Act. It discontinued the targetting of Revenue Deficit. Like mentioned above, it also defined the ‘escape clause’ clearly]
In 2019-20, the Government invoked the ‘escape clause’ to deviate from the fiscal deficit target set out at the beginning of the year by 0.5 %. It used the second condition of ‘far-reaching structural reforms in the economy’ to trigger the clause. Actually, the government had announced corporate tax cuts in 2019-20 that were expected to hit the exchequer by Rs 1.45 trillion.
Why did the states asked the Centre to raise their fiscal deficit target?
As states enacted similar legislations, they also have to maintain their deficit within 3%.
The states are asking the Centre to raise their fiscal deficit limits from 3 % to 5 % to enable increased borrowing in light of the coronavirus pandemic.
But, 5th Finance Commission chairman NK Singh said that such a change would be time-consuming as it will require a new law at the state level and the consent of the central government. A better option would be for states to invoke an “escape clause” (available for states also) to breach their FRBM mandated fiscal deficit target by 0.5 percentage points.