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Make Fiscal Discipline Enforceable & Independently Verifiable

JULY 18, 2019

By Naresh Minocha, Consulting Editor

THE Finance Ministry should introspect over fiscal opacity that figured the other day in the deliberations between two constitutional bodies.

Three days after the presentation of Union Budget, fifteenth Finance Commission (FFC) Chaired by N.K. Singh met Comptroller & Auditor General of India (CAG) Rajiv Mehrishi along with other CAG officials.

They discussed lack of underlying conceptual framework on fiscal transparency and under-reporting of deficit and debt. Another key issue that figured in talks was "Potential risks of absence of revenue deficit as a target", according to FFC release.

FFC & CAG also discussed quality of capital expenditure; asset accounting; expenditure management and impact of GST on revenue.

As put by the release, "the issue of fiscal transparency in the fiscal reporting of the Union and State Governments was discussed especially in the light of increasing trend of off-budget and extra-budgetary resource raising by the governments. CAG highlighted the fiscal risks due to non-transparency".

It adds: "International standards and amended FRBM Act, 2003 prescribes the inclusion of such off-budget resources to be included in the definition of debt. However, its completeness and reliability in the present form has been a concern for the CAG".

FFC & CAG would again meet soon to carry forward their discussion. Both are bound to raise concerns on fiscal deficiencies in their respective reports in the coming months.

Dr. Rathin Roy, Director and CEO, National Institute of Public Finance and Policy (NIPFP), has already flagged fiscal concerns immediately after the presentation of the budget.

In his column titled 'A silent fiscal crisis?' published by a leading business daily, he started with the observation: "This year's Budget speech was the first I have seen that, in my memory, has no paragraphs on the fiscal situation which, along with the tax proposals, is at the core of any Budget".

India's fiscal issues are also expected to come under scrutiny from outside quarters too. International Monetary Fund (IMF) is expected to take a call on these in the near future. This would happen when it considers annual IMF staff report on India sometime during the next four weeks.

IMF has had differences with Indian Government on definition and computation of fiscal deficit. It has, however, been highly muted in speaking on this issue. No wonder the last and the only report on India's fiscal transparency was prepared by IMF way back in 2001.

Both UPA & NDA regimes have belittled fiscal discipline as a matter of Executive's right to exercise discretion. The Government thus merrily breaches fiscal rules and changes goal posts. It does with aplomb as the Opposition neither shows the will nor the skill to debate credibility of Fiscal Responsibility and Management Act (FRBMA).

It is here pertinent to have an insider's account penned by the then Chief Economic Advisor Arvind Subramanian in January 2017.

In his capacity as member of FRBM Review Committee (FRBMRC), Dr Subramanian underscored failure of FRBM framework. In his dissent note, he suggested an alternative fiscal framework.

Listing failure of FRBM regime, he wrote: "It might actually be counterproductive to establish a revenue deficit target. The reason is that the greater the proliferation of targets, the greater the chance that the Government will ignore some of them, damaging the credibility of the entire framework. This is not just a theoretical point: it is exactly what has happened over the past decade".

Subramanian continued: "The existing FRBM already contains revenue deficit objectives, but these have been routinely ignored, so much so that this objective has essentially been forgotten. The problem is not one of negligence; it is inherent to any framework where the objectives are many and potentially conflicting".

It is obvious that Dr. Subramanian's advice emboldened Modi Government to downgrade revenue deficit (RD) as a non-statutory indicator. It has now no binding obligation on the Government. The only statutory deficit for compliance is now fiscal deficit. This too can be changed by amending fiscal rules through Finance Act as has been done repeatedly in the past.

The Government downgraded RD through FRBM (Amendment) Rules, 2018. These were notified in April 2018. Prior to this, FRBM rules specified annual targets for both fiscal deficit and RD. The FRBM rules were first notified in July 2004, marking beginning of enforcement of FRBMA, 2003.

RD's downgrade as a mere "reference indicator" runs counter to recommendation made by FRBMRC. In its report submitted in January 2017 under the chairmanship of Mr. N.K. Singh, FRBMRC specified yearly targets for both fiscal and revenue deficits.

FRBMRC proposed statutory backing to the targets by specifying them in the recommended The Debt Management and Fiscal Responsibility Bill, 2017. Instead of enacting this bill, the Government opted for amendment of FRBM Act and Rules.

Had Finance Ministry enacted the new law and abided by it, RD target for 2019-20 would have been 1.55% of gross domestic product. For accounting purposes, Union Budget for 2019-20 provides for RD of 2.3%, a 0.1% increase over revised estimate for preceding year. It is apt to recall that The FRBMA, 2003 envisaged elimination of RD by 31st March 2008.

FRBMRC did not recommend total elimination of RD while defending RD's importance in its rejoinder to Dr. Subramanian's DN. As put by the Rejoinder, "path for revenue deficit has also been included based on several discussions within the Committee, with policy makers, and with outside experts, who find revenue deficit as a useful goalpost in their day-to-day policy making process".

It continued: "In principle, the Committee believes that borrowings for expenditures that are of a recurrent nature, and that need to be incurred every year, may not be desirable, and should be tax-financed, and therefore agreed to specify a plausible guiding path for revenue deficit. The Committee, however, is also cognizant of the practical difficulties in separating current and capital expenditures".

Finance Ministry did not accept annual targets for RD & FD recommended by FRBMRC for period up to financial year ending 31st March 2023. The Government played safe by merely tinkering of FRBMA and Rules.

The Ministry did not issue any action taken report on FRBMRC. Such a report might have given some rationale for rejection of several recommendations. It would have given a clue to the fate of other recommendations on which the Government's decision is hard to come by in public domain.

The limited information on action taken is available in CAG report numbered 20 of 2018 on Compliance of the Fiscal Responsibility and Budget Management Act (FRBM), 2003 for 2016-17' released in January 2019.

As put by CAG, "With regard to not including the indicator of revenue deficit, the Government argued that there is little or no evidence to say that capital expenditure should enjoy pre-eminence over revenue expenditure in a country like India. Moreover, expenditure of revenue nature such as health and education also enhance human capital formation".

CAG noted that the Government did not provide any specific reason in budget documents for not constituting Statutory Fiscal Council as recommended by FRBMRC.

"The information and analysis provided by fiscal councils can alert the public when policymakers are on an undesirable fiscal trajectory", says IMF's Staff Discussion Note (SDN) titled 'Second-Generation Fiscal Rules: Balancing Simplicity, Flexibility, and Enforceability'.

Published in April 2018, SDN adds: "the budget is often too opaque and complex for the public to understand. Well-resourced and truly independent fiscal councils can enhance existing signals about the competence of policymakers, thereby raising the reputational costs of breaching the rule".

FRBMRC recommended that Fiscal Council would prepare The Macroeconomic Framework Statement (MFS), which would be presented to Parliament.

FRBMRC suggested that MFS should provide an assessment of the economy. It should report on trends in the growth of GDP, public debt, fiscal balance and the external balance.

Thus, absence of statutory mechanism for independent monitoring of fiscal performance is yet another fatal flaw in working of FRBMA.

As regards fiscal transparency, FRBMRC recommended that the Government should move towards international best practices for compilation and presentation of fiscal accounts, as laid out in IMF's Government Finance Statistics Manual 2014.

IMF's analysis of fiscal rules in different countries shows gaps in Indian fiscal framework. The Analysis titled 'Fiscal Rules at a Glance' issued in 2017 shows India has no formal enforcement procedure for fiscal rules. It has no "independent body" that sets "budget assumptions". It has no independent body to monitor fiscal rules implementation.

The existing analysis shows the Government treats national economic interests as subservient to its political compulsions. As long as this mindset does not change, fiscal discipline would remain an accounting gimmick.

Should the fiscal problems be under-reported or camouflaged till they explode as an economic crisis? The answer to this question depends on Government's willingness to listen to criticism in the long-term interest of the country.