Fiscal Stress on Indian Economy: ‘States can use escape clause too’

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Published: February 14, 2020 4:30:51 AM

In fact, the rules allow the escape clause to be invoked after the 3% target for fiscal deficit is achieved. The Centre's fiscal deficit for FY20 was originally budgeted at 3.3% and 0.5% deviation increased it to 3.8% (RE).

NK Singh on Thursday said the FC has set up a ‘Group on Defence and Internal Security’ headed by him

Taking a cue from the Centre, which invoked an exigency clause under FRBM law to enable a deviation of 0.5% of GDP each from the fiscal deficit road map for both FY20 and FY21, the state governments could also amend their respective laws to use the clause and create extra headroom for spending, 15th Finance Commission chairman NK Singh said on Thursday.

“It’s their (states) option, but if they exercise it, there comes the obligation of having a credible debt (reduction) trajectory. They don’t have to ask the Finance Commission for this exemption clause,” Singh said. The state governments could include this provision in their respective FRBM Acts, he added.

The state governments have been on the path of fiscal consolidation and their combined fiscal deficit remained below the targets in FY19. For FY20, the states have budgeted for gross fiscal deficit of 2.6% as against 2.4% in FY19. However, the lower transfer of resources from the Centre from the divisible pool and weak performance of their own tax revenues could hamper their ability to stick to the fiscal deficit target in this fiscal.

Given the sharp economic slowdown, the demand for counter-cyclical fiscal measures was gaining traction, at least two state finance ministers had told the Union finance minister in December to let the fisc to expand to counter the economic slowdown. “The biggest take home from pre-budget discussion of FMs is suggestion by Bihar and Kerala to raise the fiscal deficit limit to 4%. It was agreed to (by) a large number of states,” Kerala finance minister Thomas Isaac had tweeted on December 18, 2019.

The states have continued on the path of fiscal consolidation and contained the fiscal deficit within the targets set out by the FRBM Act in recent years except in FY17 owing to the UDAY obligations. As per state budgets, their combined fiscal deficit stood at 2.4% of GDP in FY19 and the target (BE) for FY20 is 2.6%. However, sharp cut in transfer of tax revenue from the Centre and low growth in their own tax revenue could hamper their ability to stick to the fiscal deficit target for the current fiscal.

In fact, the rules allow the escape clause to be invoked after the 3% target for fiscal deficit is achieved. The Centre’s fiscal deficit for FY20 was originally budgeted at 3.3% and 0.5% deviation increased it to 3.8% (RE). The circumstances cited by the NK Singh panel for use of the escape clause inter alia include over-riding consideration of national security, acts of war, collapse of agriculture severely affecting farm output and incomes, structural reforms in the economy with unanticipated fiscal implications and decline in real output growth of a quarter by at least 3 pps below its average of the previous four quarters. Given that despite the sharp slide in GDP growth, the latest available quarterly GDP expansion rate of 4.5% (Q2) was only 1.6 pps lower than the average of the previous four quarters, at least that definite condition has not been met really. The condition of ‘structural reforms’ and farm income leave sufficient room for interpretation.

The commission’s first report, tabled in Parliament on February 1 and applicable for FY21, has kept tax devolution to states unchanged at 42%. However a rejigging of the weights assigned to various parameters and the use of 2011 census significantly altered the inter se shares of some states in the overall tax revenue transferred to them. The biggest gainers are Maharashtra, Rajathsan, Bihar and MP, while Karnataka, Kerala, Telangana and Assam saw their shares shrinking. Uttar Pradesh’s share also declined marginally from the 14th FC award period. “We have acted in accordance with the legacy which we inherited… (which is of) acting as a neutral constitutional body,” Singh said.

Separately, Singh on Thursday said the FC has set up a ‘Group on Defence and Internal Security’ headed by him “to examine whether a separate mechanism for funding of defence and internal security ought to be set up, and if so, how such a mechanism could be operationalised”. Some states had expressed concern that such a provision could further reduce the resources available to them from the divisible pool.

Another panel to be headed by Singh will also be formed soon to suggest to the commission on how to strengthen the legal framework for oversight of the Centre and states’ debt and fiscal deficit road map. The extant FRBM Act is anchored on fiscal deficit criteria only.

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