Deficit Targets: A 21st century fiscal architecture for India

April 06, 2021 5:20 AM

India needs an independent fiscal council with powers to access state and central govt records as required—a key 14th and 15th Finance commission recommendation

economyGST mop-up registered a good growth and collections exceeded Rs 1 lakh crore in each of the last six months owing to economic recovery.

By M Govinda Rao

The pandemic has seen unprecedented slippage in the fiscal targets. According to the Centre’s revised estimate for 2020-21, the fiscal deficit, at Rs 18 trillion (or 9.5% of GDP), was massive and, in addition, the states would have incurred a deficit of Rs 25.5 trillion (totalling 13.5% of GDP)—such slippage was never seen before. Total outstanding liabilities is likely to be close to 90% of GDP. At the central level, the actual revenue collections seem to have marginally exceeded the revised estimate, due to better income tax and GST collections, in March; but, the overall numbers  are likely to remain at close to the revised estimate. In the case of state, too, better GST collections and tax devolution and deliberate compression of capital expenditures are likely to contain the fiscal deficit at about 4% of GDP.

The high levels of deficit and debt do not come as a surprise. The catastrophe caused by the pandemic on the lives and livelihoods of the people was unprecedented, and the sharp contraction in revenues at both central and state levels contributed to the steep upsurge in fiscal deficit. For the next year, the fiscal deficit of the Centre is estimated at Rs 15 trillion, or 6.8% of GDP and, assuming that the states continue to borrow close to 4% of GDP, the total government deficit will be Rs 23.9 trillion or 10.8% of GDP.

While the large borrowings for FY21 could not have been avoided, it must be noted that RBI, to enable the government to borrow at low-cost, had to control the yields by massive infusion of liquidity from time to time through open-market-operations and the Operation Twist. Besides significant reduction in the repo rate, the yields on government securities had to be kept low, which implies that the banks had to reduce the rates on fixed-deposits. Keeping interest rates on small savings at high levels created a downward rigidity on deposit rates as the banks, for fear of losing their deposits, could not further reduce the already low rates.

Not surprisingly, the government wanted to align these rates, but the decision was quickly reversed for political reasons. The government will have to quickly start the process of fiscal consolidation to bring down the levels of deficits and debt. The Fifteenth Finance Commission has recommended a consolidation plan providing a target range. Assuming that the base-year fiscal deficit estimate in FY21 is 7.4%, the Commission’s report states that if the economic recovery is slower than that was assessed by it, the fiscal deficit should be brought down from 6.5% in FY22 to 4.5% in FY26. If the recovery conforms to the assessment, the consolidation will be from 6% in FY22 to 4% in FY26. And, if the recovery is faster, the consolidation should be from 6% to 3.5%.

The revenue deficit is supposed to be reduced from 4.9% in FY22 to 2.8% in FY26, and outstanding liabilities are to be reduced from 61% to 56.6% during the period. In the case of the states, the indicative deficit limit is supposed to be reduced from 4% of GDP in FY22 to 3% in FY24 and remain at that level thereafter. The debt ceiling for the states relative to GDP varies from 32.5% in FY22, increases to 33.3% in FY23 and marginally declined thereafter to 32.6% in FY26. Thus, the aggregate fiscal deficit relative to GDP is supposed to be reduced from 9.3% in FY22 to 6.8% in FY26, and outstanding liabilities are supposed to be reduced from 88.3% to 85.7% during the period.

The Commission has also suggested a major restructuring of the FRBM Act by a High-Powered Intergovernmental Group to design the FRBM framework and oversee its implementation. The Union government is silent on this recommendation, but the recommendation on net borrowing ceilings for the states has been accepted in-principle. As far as the Union government’s own fiscal deficit consolidation is concerned, the finance minister, in her budget speech, has set the target of 4.5% of GDP by FY26. It appears, the government either does not expect the recovery to be fast or wants to have a more relaxed consolidation schedule.

In its chapter titled ‘Fiscal Architecture for 21st Century India’, the Commission has made important recommendations for more effective conduct of rule-based fiscal policy, improved fiscal management practices and institutional reforms. It has recommended a series of Public Financial Management Reforms to have more comprehensive coverage and reporting, improved macroeconomic and fiscal forecasting, improvement in cash-management practices—to enhance operational efficiency and ensure greater transparency and accountability. On fiscal accounting, the Commission has recommended a time-bound plan for the phased transition to standards-based accounting and financial reporting, towards the eventual adoption of accrual-based accounting system.

One of the most important recommendations of Fifteenth Commission, like its predecessor, is the establishment of an independent fiscal council with powers to access records as required from the Union and the states. The recommendations made by the Thirteenth Finance Commission and the Fiscal Review Committee were to have the fiscal councils be appointed by the finance ministry and have them report to it—in which case, it ceases to be independent. In contrast, the Fourteenth Finance Commission recommended the amendment of the FRBM Act to enable Parliament to appoint the Council and have it report to it.

The Fifteenth Commission has recommended the appointment of an independent council. Based on international practices, it has listed a number of indicative functions that include (i) providing multi-year macro-economic and fiscal forecasts; (ii) evaluating fiscal performance vis-à-vis targets across levels of government; (iii) assessing the appropriateness and consistency of fiscal targets in the States; (iv) carrying out independent assessments of long-term fiscal sustainability; (v) assessing fiscal policy statements by governments under fiscal responsibility legislations; (vi) advising on the conditions for using escape clauses; (vii) policy costing of new measures with significant fiscal implications; (viii) providing analytical support to the Finance Commissions, including at state levels; and (ix) publication of all their reports and underlying methodologies.

Of course, to begin with, it may be advisable to entrust the Council with a smaller mandate which includes undertaking macroeconomic and fiscal forecasts, policy costing of new measures with significant fiscal implications and evaluating fiscal performance vis-à-vis targets. This is an important recommendation for the 21st century fiscal architecture for India, but the Union government has been silent on its implementation in the Action Taken Report.

(Author is Chief economic adviser, Brickwork Ratings, and member, Fourteenth Finance Commission. Views are personal)

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