Ashita AllamrajuAssociate Professor

Administrative Staff College of india

FRBM, Fiscal and Revenue Deficit

Basic ConceptsWhat is the difference between revenue

and capital?Capital: relates to creation/liquidation of an

assetirregular

Revenue: routine requirementsFairly regular

Some DefinitionsRevenue Deficit= Revenue Expenditure – Revenue

Receipts

Fiscal deficit = Total expenditure - (Revenue Receipts +recoveries of loans + Other capital Receipts )

Effective Revenue Deficit = Revenue Deficit- Grants for Creation of Capital

assets

Trends in DeficitFiscal deficit till

September, 2015 was Rs3,78,563 crore which amounts to 68.1 per cent of the BE 2015-16.

Revenue deficit for April-September, 2015 was Rs.2,69,008 crore as against the budget estimates of 2015-16 of Rs.3,94,472 crore.

Revenue deficit was 68.2 per cent of BE

Assessing Quality: Capex and Social Sectors

Deficit Indicators of State Governments

Issue 1: Why do fiscal imbalances occur: need for FRBM?

Two Reasons1) Someone else’s money spent on someone

else!

4 Ways to spend money - Milton Friedman

Fiscal Imbalances are a common pool problem– When you go to a restaurant with nine friends and decide to share

the bill, you will only have to pay for 10 % of the excesses you incur, but you will be partially liable for the excesses of your friends.

– Suppose there are two options: a cheaper meal, say for Rs. 1, and an expensive meal for Rs5. Assume that if you went on your own, you would choose the cheaper meal. Notice, however, what happens if you go in a group and share the bill. If the nine friends choose the cheaper meal, you could choose the cheaper meal for 1 or the expensive meal and pay only 1.40 [(9x1+5)/10].

– Alternatively, if your friends all choose the expensive meal, you could choose the cheaper meal and pay Rs4.6 or the expensive meal and pay Rs5.

Cheap Meal Expensive MealCheap Meal 1,1 1.4 , 1.4Expensive Meal 4.6, 4.6 5,5

Friends

Fiscal policy involves expenditures that are paid out of a common pool of public revenues and hence suffer a similar problem, only that it involves much more than ten people, not all of them friends, making problems so much harder.

Institutional Reforms Numerical Rules (like FRBM)Procedural Rules (like GFR)Transparency Rules (like RTI)

Fiscal Responsibility and Budget Management Act

FRBMThe FRBM Bill / Act provides rules for fiscal

responsibility of the Central Government. The FRBM Act 2003 (as amended) became effective from July 5, 2004

Objectives of FRBM Act 2003 To reduce fiscal deficit To adopt prudent debt management. To generate revenue surplus.

Three Planks of StrategyLimits on government borrowing under a time

bound programme to altogether eliminate revenue deficit and bring down fiscal deficit

Bringing a medium term perspective in Budget planning through the introduction of certain statements to accompany the budget the introduction of certain statements to accompany the budget document.

Improving transparency in the fiscal operations of the government in order to avoid any window dressing in meeting the deficit targets as well as improving fiscal discipline.

Features of the FRBM Act/RulesRules specify annual targets for Revenue and Fiscal deficitAs per the amendments in 2012, the Central Government has

to take appropriate measures to reduce the fiscal deficit, revenue deficit and effective revenue deficit to eliminate the effective revenue deficit by the 31st March, 2015 and thereafter build up adequate effective revenue surplus and also to reach revenue deficit of not more than 2 % of Gross Domestic Product by the 31st March, 2015 and thereafter as may be prescribed by rules made by the Central Government.

Vide the Finance Act 2015, the target dates for achieving the prescribed rates of effective deficit and fiscal deficit were further extended. The effective revenue deficit which had to be eliminated by March 2015 will now need to be eliminated only after 3 years i.e., by March 2018. The 3% target of fiscal deficit to be achieved by 2016-17 has now been shifted by one more year to the end of 2017-18.

Public Debt The central government should ensure that

the total liabilities (including external debt at current exchange rate) should not exceed 9% of GDP for the financial year 2004-2005. There should be progressive reduction of this limit by atleast one percentage point of GDP in each subsequent year

FRBM: DisciplineIn the mid-year review at end of 2nd quarter every

year, if : Total non-debt receipts are < 40 % of BE of that year or Revenue Deficit is > 45 % of BE of that year Or Fiscal Deficit is > 45 % of BE of that year then action is triggered as stipulated under Section

7(2) and Section 7(3) of the Act, namely : u/s 7(2) Govt. shall take appropriate measures to

increase revenue or curtail expenditure and u/s 7(3) Finance Minister is required to make a

statement in the Parliament on the ‘State of Central Govt. Finances’

State Wise Analysis of Impact of FRBM

Marginal reductions in revenue expenditures.

Are Fiscal Rules Helpful?Charles Wyplosz, reviewing global experience with

fiscal rules (NBER Working Paper No. 1788), concludes they are neither necessary nor sufficient to ensure good behaviour, but they can be potentially helpful.

The FRBM Act succeeded in disciplining the states, because the states cannot borrow without the permission of the centre, but it was spectacularly ineffective in disciplining the centre.

Sovereign governments are not easily disciplined by fiscal rules unless Parliament is an effective watchdog.

Reasonable Fiscal DeficitThe Fourteenth Finance Commission has

explicitly recommended a 3% fiscal deficit for the centre and another 3% for the states, yielding a combined limit of 6% per year for the period 2015-16 to 2019-20.

Is a combined deficit of 6% reasonable? Crowding out of private Investment?

In 2007-08, the net financial saving of households was about 11.6% of GDP and the combined fiscal deficit of the centre and states together was only 4.1%.

This meant that 7.5% of GDP was left for the corporate sector. We know that private investment boomed at that time.

Net financial saving of the household sector has declined to about 7.3% of GDP. This probably reflects higher levels of inflation, prompting households to shift from financial assets to real estate and gold. If the combined fiscal deficit is fixed at 6% of GDP, it would leave only 1.3% of the GDP for the corporate sector!

Thank you!