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This article was first published 4 years ago  » Business » Why did Nirmalaji deviate from fiscal deficit target?

Why did Nirmalaji deviate from fiscal deficit target?

By A K Bhattacharya
February 21, 2020 14:28 IST
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The government should have mentioned clearly the specific structural reforms that were responsible for the deviation from the fiscal deficit target by half a percentage point, says A K Bhattacharya.

Fiscal deficit

Illustration: Uttam Ghosh/

While presenting her second Union Budget on February 1, Finance Minister Nirmala Sitharaman justified the slippage of 0.5 percentage points in the fiscal deficit on the ground that the deviation was consistent with the escape clause provisions in the Fiscal Responsibility and Budget Management Act.

Instead of the promised fiscal deficit of 3.3 per cent of gross domestic product in 2019-2020, she presented a revised estimate of 3.8 per cent, and instead of the earlier fiscal deficit projection of 3 per cent for 2020-2021, she proposed a deficit of 3.5 per cent of GDP.

Understanding the circumstances under which the finance minister chose to use the escape clause under the FRBM Act will be a useful exercise.

Equally important and instructive will be an assessment of what the use of such a provision might mean for the government's fiscal consolidation road map.

The FRBM Act was legislated in 2003 to impose fiscal discipline on government finances.

Among other things, it mandated the government to adhere to a path of fiscal consolidation to reduce the fiscal deficit to 3 per cent of GDP.

The law came against the backdrop of fiscal profligacy.

In each of the six years prior to the FRBM Act's legislation, the fiscal deficit had stayed well above 5 per cent of GDP and in one of the years it had even crossed the 6 per cent mark.

The new law made a difference, but only in the first few years.

The government's fiscal deficit declined steadily from 4.3 per cent in 2003-2004 to 2.5 per cent of GDP in 2007-2008.

However, all fiscal caution was thrown to the wind and the deficit stayed at elevated levels of between 4.5 and 6.5 per cent of GDP from 2008-2009 to 2013-2014.

Subsequently, fiscal consolidation efforts were steady with the gradual reduction in the deficit from 4.1 per cent in 2014-2015 to 3.5 per cent in 2017-2018.

It was in February 2018 that, based on some of the recommendations of an expert group, the government amended the FRBM Act to tighten its provisions and introduce an escape clause.

Significantly, the amended law targeted not just the fiscal deficit, but also the debt of the government.

On debt, it stipulated that the general government debt (including those at the Centre and the states) should not exceed 60 per cent of GDP and the Centre's debt should be kept below 40 per cent of GDP by 2024-2025.

On deficit, the amended FRBM Act bound the Centre to take steps to limit the fiscal deficit up to 3 per cent of GDP by the end of 2020-21.

The escape clause provided that the fiscal deficit could be exceeded by half a percentage point in a year on any of the following grounds: National security, act of war, national calamity, collapse of agriculture severely affecting farm output and incomes, structural reforms in the economy with unanticipated fiscal implications and a decline in real output growth of a quarter by at least three percentage points below its average of the previous four quarters.

Interestingly, the amended FRBM Act also provided for a reduction in the fiscal deficit target by 0.25 percentage point of GDP in a year, if GDP growth in a quarter increased by three percentage points over the average of the previous four quarters.

In the case of either an upward or downward revision in the deficit, the government was required to make a statement explaining the reasons and outlining the path of return to annual prescribed targets before both Houses of Parliament.

What did Ms Sitharaman do while seeking recourse to the escape clause under the FRBM Act?

She justified her move by stating that the law provided for 'a trigger mechanism for a deviation from the estimated fiscal deficit on account of structural reforms in the economy with unanticipated fiscal implications.'

Which structural reform was the finance minister referring to?

All that she mentioned in her speech, while referring to the deviation in the deficit target, was that the government had undertaken significant tax reforms for boosting investments and that the expected tax buoyancy would take time.

It is most likely that this was a reference to the sharp cut in corporation tax rates, which she had announced in September 2019 and as a result of which the revenue foregone amount was estimated at about Rs 1.45 trillion in 2019-2020.

But the revenue foregone amount was clearly an overestimate.

The statement on fiscal policy, tabled in Parliament, presents a slightly different picture on the likely fiscal impact of the corporation tax rate cut.

It estimates that a stimulus of Rs 1 trillion (0.5 per cent of GDP) has been provided by way of lowering the corporation tax rates.

Elsewhere, the statement mentions a series of steps that the government took like the corporation tax rate cut, an increase in the minimum support price of agricultural crops, policy initiatives for textiles and electric vehicles, incentives for start-ups, measures for non-banking financial companies, relaxation of external commercial borrowing norms for affordable housing, merger of 10 public sector banks and streamlining of labour laws.

But it does not identify any one of them as a structural reform, though it does point out that some of these steps would have fiscal implications with a spill-over effect in the next financial year as well.

The government would have done well to have mentioned clearly the specific structural reforms that were responsible for the deviation from the fiscal deficit target by half a percentage point.

This was necessary as the escape clause clearly states that such deviation will be allowed as a result of structural reform with unanticipated fiscal implications.

It is not clear, either from the finance minister's speech or the fiscal policy statement, why fiscal policy implications of a corporation tax rate cut or of any others measures were unanticipated.

The finance minister's Budget speech is equally unclear on the question of the other target under the FRBM Act, the target of reducing the Centre's debt.

Referring to the Centre's debt, Ms Sitharaman said: 'The central government debt that has been the bane of our economy got reduced, in March 2019, to 48.7 per cent of GDP from a level of 52.2 per cent in March 2014.'

However, the fiscal policy statement shows that the Union government's total debt has risen from 48.7 per cent of GDP in 2018-2019 to 50.3 per cent in 2019-2020.

And for 2020-2021, this is expected to stay at 50.1 per cent of GDP.

The government expects that with increased revenue collections, borrowings would reduce and the government's debt would reach 48 per cent in 2021-2022 and to 45.5 per cent of GDP in 2022-2023.

Remember that the target is to reach 40 per cent by 2024-2025, unless the law is again amended to introduce another escape clause!

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A K Bhattacharya
Source: source

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