Fiscal Responsibility and Budget Management (FRBM) Act

February 24, 2024

9 Minutes

FRBM Act UPSC

Introduction

 The Fiscal Responsibility and Budget Management (FRBM) Act, 2003, is a central piece of legislation in India. It plays a crucial role in ensuring sound fiscal management within the government. This act establishes rules and parameters that guide the government's budgetary decisions, aiming for greater financial prudence and long-term stability. UPSC aspirants must have a solid grasp of the FRBM Act due to its significance in the Indian economy and its frequent presence in the UPSC syllabus.

Rationale behind the FRBM Act

The enactment of the FRBM Act had several driving factors:

• Rising Fiscal Deficits: During the 1990s, India experienced persistently high fiscal deficits. These deficits indicate that government spending exceeded government revenue, leading to borrowings to bridge the gap. This caused concerns about excessive government debt.

• Need for Fiscal Discipline: There was a pressing need to instill greater financial discipline into government spending. The FRBM Act aimed to reduce deficits and debt, enabling more efficient resource allocation.

• Macroeconomic Stability: The FRBM Act sought to promote overall macroeconomic stability. Containing fiscal deficits helps control inflation, supports stable interest rates, and encourages investment.

Key Objectives of the FRBM Act

• Reduce Fiscal Deficit: The FRBM Act sets specific targets for the reduction of the fiscal deficit, which represents the excess of the government's total expenditure over its total income (excluding funds acquired through borrowing). 
• Eliminate Revenue Deficit: The Act also focuses on eliminating the revenue deficit entirely. This deficit occurs when the government's regular income falls short of its recurring expenses.
• Debt Management: The Act emphasizes prudent debt management, aiming to restrict the government's reliance on excessive borrowing.
• Intergenerational Equity: The FRBM Act promotes intergenerational equity by ensuring that the present generation's financial decisions do not unfairly burden future generations.
• Transparency and Accountability: The Act fosters transparency by mandating the government to present various fiscal statements to the Parliament, such as the Medium-term Fiscal Policy Statement.

Provisions of the FRBM Act

• Deficit Targets: The FRBM Act originally aimed to reduce the fiscal deficit to 3% of the GDP and eliminate the revenue deficit entirely by March 2008.  However, various factors, including the global financial crisis of 2008, have led to numerous revisions and extensions of these targets throughout the years.
• Fiscal Responsibility Statements: The Act necessitates that the government present the following statements to the Parliament along with the annual budget:
• Limitations on Borrowings: The FRBM Act puts restrictions on the government's power to borrow from the Reserve Bank of India (RBI), except through temporary means like Ways and Means Advances.
• Escape Clause: The FRBM Act contains an "escape clause" under Section 4(2). This clause permits the government to exceed the fiscal deficit targets under exceptional circumstances such as:

The NK Singh Committee and FRBM Review

In 2016, the government established a committee headed by N.K. Singh to review the FRBM Act. The committee's recommendations included:

•  Adopting a Debt-to-GDP Ratio: Recommending that the government focus on a debt-to-GDP ratio of 60% (40% for the Central government and 20% for states) as the primary fiscal target. This shift aimed to provide a more comprehensive picture of the government's debt burden in relation to the size of the economy.
•  Flexibility: Allowing for some flexibility in meeting fiscal targets during economic downturns through the establishment of an 'escape clause'. This clause would specify conditions (e.g., severe growth declines, national emergencies)  under which deviations from targets could be justified.

Additional Recommendations: 

The committee also emphasized:

• Creating an independent Fiscal Council to monitor fiscal performance and advise the government
• Improving the quality of fiscal data for better decision-making
• Strengthening the relationship between fiscal and monetary policy for overall macroeconomic stability

Significance of NK Singh Committee's Recommendations

•  Changing Focus: The NK Singh Committee's recommendations mark a potential shift in India's approach to fiscal management. UPSC aspirants need to understand the rationale behind moving from primarily focusing on fiscal deficits to targeting a debt-to-GDP ratio.
•  Policy Debates: The concept of flexibility and escape clauses within fiscal rules leads to crucial policy discussions surrounding rigid targets versus the need for adaptive responses during economic crises.
• Institutional Framework: The suggestion of an independent Fiscal Council is important for aspirants to grasp as it touches upon issues of government accountability and transparency in fiscal policymaking.

Benefits of the FRBM Act

The FRBM Act has been instrumental in bringing about several positive changes in India's fiscal landscape. Some key benefits include:

• Greater Fiscal Discipline: The Act has imposed a greater sense of discipline on government spending. The targets and restrictions outlined in the Act encourage more prudent resource allocation and a focus on long-term fiscal health.
• Improved Debt Management: By placing focus on reducing deficits and limiting borrowings, the FRBM Act has contributed to a more sustainable approach to managing the government's debt levels.
• Enhanced Macroeconomic Stability: The fiscal consolidation resulting from the FRBM Act has helped maintain price stability, control inflation, and promote a more conducive investment environment within the economy.
• Transparency and Accountability: The various fiscal statements mandated by the FRBM Act have enhanced transparency in government budgeting. This transparency also increases government accountability in the management of public finances.
• Credibility and Market Confidence: Adherence to the principles of the FRBM Act signals fiscal prudence to both domestic and international investors. This helps boost India's credibility and improve market confidence in the economy.

Latest Changes to FRBM Act in Budget 2021

• Fiscal Deficit Target: The 2021-22 budget sets a fiscal deficit target of 6.8% of GDP, reflecting continued efforts towards fiscal consolidation. [Note: You can add a brief sentence defining fiscal deficit earlier in the article if you haven't already]

• Total Expenditure: The government's proposed total expenditure for FY 2021-22 stands at Rs. 34,83,236 crore.

• Priority Shifts: Budget allocations highlight certain shifts in government spending priorities:

• Jal Jeevan Mission: A substantial 123% increase in funding signals a focus on providing clean water access.

• Welfare Programs: Allocations for women's welfare programs have decreased compared to 2020-21 (revised estimates), while increased funding is directed towards programs for Scheduled Castes (SC) and Scheduled Tribes (ST).

• Northeastern Region: Development of the Northeastern region receives a boost with a significant 32.7% increase in allocated funds.

Conclusion

The FRBM Act remains a dynamic area of discussion with frequent amendments and reviews. UPSC aspirants should stay informed about current developments and critically analyze the evolving landscape of India's fiscal policy.

Practice Questions

Multiple Choice Questions

1. Consider the following statements regarding India's fiscal deficit:

A. Fiscal deficit always represents a net borrowing requirement of the government.

B. Revenue deficit adds directly to the fiscal deficit.

C. Primary deficit indicates the amount of borrowing required to meet interest payments.

Which of the above statements is/are correct?

1. Only A and B
2. Only B and C
3. Only C
4. All of the above

2. With reference to the Fiscal Responsibility and Budget Management (FRBM) Act, consider the following statements:

A. The FRBM Act mandates the presentation of a Medium-Term Expenditure Framework Statement along with the annual budget.

B. One of the initial objectives of the FRBM Act was to limit the central government's fiscal deficit to 2% of the GDP.

C. The NK Singh Committee recommended a shift from a fiscal deficit target to a debt-to-GDP ratio target.

Which of the above statements is/are correct?

1. Only A
2. Only B and C
3. Only A and C
4. All of the above

3. Which of the following situations can trigger the 'escape clause' under the FRBM Act?

A. An increase in oil prices leading to higher subsidies.

B. A decline in tax revenues due to an economic recession.

C. Expenditures exceeding budgeted amounts due to a natural disaster.

Which of the above statements is/are correct?

1. Only B
2. Only B and C
3. Only A and C
4. All of the above

4. In the context of the FRBM Act, consider the following statements:

A. The central government cannot borrow directly from the Reserve Bank of India (RBI) except for temporary liquidity needs.

B. The FRBM Act places no restrictions on the fiscal deficits of state governments.

C. The government must take measures to reduce the fiscal deficit to zero every financial year.

Which of the above statements is/are correct?

1. Only A
2. Only A and B
3. Only B
4. None of the above

Answer Key

• Answer: 2 (Only B and C)
• Answer: 3 (Only A and C)
• Answer: 2 (Only B and C)
• Answer: 1 (Only A)

Mains-Style Subjective Question

Question: Critically examine the rationale behind the recommendations of the NK Singh Committee on the FRBM review. Discuss the potential benefits and challenges associated with implementing these recommendations.

Model Answer

The NK Singh Committee, constituted in 2016, made significant recommendations regarding changes to India's fiscal management framework governed by the FRBM Act. Understanding the rationale driving these recommendations and their implications is crucial for policymakers and administrators.

Committee Recommendations and Rationale

• Debt-to-GDP Focus: Shifting the primary fiscal target to the debt-to-GDP ratio aimed at providing a more holistic assessment of the government's debt burden in relation to the size of the economy.
• Flexibility with Escape Clause: The committee sought greater flexibility in meeting fiscal targets, particularly in times of economic downturns, by formalizing escape clause provisions.
• Independent Fiscal Council: The suggested creation of a Fiscal Council aimed to provide expert, non-partisan advice and oversight regarding fiscal performance,enhancing transparency and accountability.

Benefits and Challenges

• Benefits: Potential benefits include better alignment of fiscal policy with long-term sustainability, calibrated responses in economic crises, and increased credibility through enhanced oversight mechanisms.
• Challenges: Concerns exist around the complexity of setting appropriate debt-to-GDP targets, the potential for misuse of the escape clause, and the Fiscal Council's potential capacity and independence issues.

The NK Singh Committee's recommendations reflect the evolving complexities of fiscal management. While offering potential advantages, their implementation requires careful consideration to ensure both fiscal prudence and the adaptability to address economic needs.