Responsibility and Democratic Accountability
26th 2004, C.P. Chandrasekhar and Jayati Ghosh
of the first legislative actions of the UPA government
was to notify the Fiscal Responsibility and Budget
Management Act (henceforth FRBM Act). This Act was
notified on 2 July to come into force on 5 July 2004,
only three days before the presentation of the Annual
Budget, thereby circumscribing the entire budgetary
exercise from the start of the new government’s tenure.
FRBM Act is apparently well-intentioned, designed
to clean up public finances and put them on a sustainable
footing. Thus, it requires the reduction of the fiscal
deficit and the elimination of the revenue deficit
of the Central Government by 31 March 2008 (the deadline
is to be extended by a year). This would appear to
be a way of forcing the government to adhere to a
discipline which would thereby allow it to spend more
on useful capital expenditure.
However, the actual implications of the working of
the Act are much more serious and potentially adverse,
than is generally understood. Some of the requirements
of the FRBM Act and the associated rules mentioned
in the notification, are described in Table 1.
The Act requires the Central Government to reduce
the fiscal deficit by 0.3 per cent of GDP each year,
and the revenue deficit by 0.5 per cent each year,
beginning with this financial year. If this is not
achieved through higher tax revenues, the necessary
adjustment has to be made by cutting expenditures.
Further, the Act prohibits the Central Government
from borrowing from the Reserve Bank of India (that
is deficit financing, involving the printing of money)
to meet its deficit, except for temporary cash advances.
This effectively rules out a cheap source of borrowing
and forces the government to borrow at much higher
rates, for no evident reason. The RBI is even to be
prohibited from making primary market purchases of
But the limitation on borrowing from the RBI, or deficit
financing, is not at all something that can be easily
justified. The argument that deficit financing causes
inflation is not just simply wrong. It is now widely
acknowledged across the world to be ridiculous and
completely unwarranted, especially in the financially
sophisticated world we live in. Inflation control
does not at all depend upon controlling the central
government’s borrowing directly from the RBI.
So this directive does not serve any useful purpose.
Instead, it unnecessarily forces the government to
pay much higher interest on all its debt, instead
of allowing for some low interest debt to the RBI.
This raises the interest cost of the government and
thereby the total revenue expenditure, perversely
making it harder to achieve the revenue deficit targets.
It is hard to understand why this portion of the Act
has been retained even when earlier discussion in
Parliament pointed to the absurdity of this condition.
Furthermore, as can be seen from Table 1, the FRBM
Act and Rules require a continuous reduction in revenue
and fiscal deficits over the next four years, regardless
of the prevailing macroeconomic circumstances. This
insensitivity even to more obvious patterns such as
the business cycle (which typically affects tax revenues
and therefore public deficits) makes the entire legislation
excessively rigid and ties the government’s hands
even in terms of responding to the needs of its citizens.
But the most worrying – and potentially undemocratic
– part of the FRBM Act relates to compliance conditions.
The Act states that “whenever there is a shortfall
in revenue or excess of expenditure over the pre-specified
levels….the Central Government shall take appropriate
measures for increasing revenue or for reducing the
expenditure (including curtailing of the sums authorised
to be paid and applied for from and out of the Consolidated
Fund of India under any Act so as to provide for appropriation
of such sums).”
The notification spells this out even more clearly:
“In case the outcome of the quarterly review of trend
in receipts and expenditure…at the end of any financial
year… shows that
the total non-debt receipts are less than 40 per
cent pf the Budget Estimates for that year; or
the fiscal deficit is higher than 45 per cent of
the Budget Estimates for that year; or
the revenue deficit is higher than 45 per cent of
the Budget Estimates for that year,
the Central Government shall take appropriate corrective
This means that if any of these conditions holds (which
is very likely in most years) the government will
in effect be forced to cut expenditures even if they
are essential for the economy, or required to enforce
its popular mandate or to deliver the socio-economic
rights of the citizens.
This is going to hit home much faster than many people
realise. The Budget 2004-05 contains what are widely
recognised to be inflated and highly optimistic revenue
receipt projections. Also, the overwhelming part of
additional resource mobilisation in the budget is
backloaded, to be available only after September.
In addition, the truant monsoon is bound to depress
revenues. By September, it is not just likely but
almost inevitable that the actual revenue receipts
will fall short of the Budget estimates by 40 per
cent or more.
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