Transcript MONETARY AND FISCAL POLICY functions

FISCAL RESPONSIBILITY AND BUDGET
MANAGEMENT
(WITH REFERENCE TO FRBM ACT 2003)
The Institute of Chartered Accountants of India
Bangalore
CA & CS Pratap G. Subramanyam
BACKGROUND
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FRBM is a new dispensation in India’s fiscal and
budgetary management system in line with global
practices in this area (US, UK, Eurozone).
The dismantling of the Bretton Woods system by
the US under Richard Nixon post the oil crisis in
1973 and subsequent adoption of the Gramm
Rudman Hollings Balanced Budget Act led to the
present budgetary system.
The US government presently has authority within
the constitution to prepare budgets wherein the
deficits are met by borrowings from market. The
cumulative debt is capped by legislation.
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BACKGROUND
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In Europe, the Maastritch Treaty was signed to form
the Euro Zone. Under this Treaty, the respective
governments have to finance their respective
budgetary deficits through market borrowings.
The fundamental principle under this system is
that the Central Bank of the country will not
monetise budgetary deficits automatically.
Governments have to fund budgetary deficits
through market borrowings. The Central bank can
only conduct open market operations as part of its
monetary management function. This is the precise
problem for countries like Greece, Spain and
Portugal.
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BACKGROUND
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In India, prior to the FRBM Act, central government
deficits were financed through monetisation of
deficits by the RBI (a process known as ‘Deficit
Financing’). The state governments have no such
facility and their deficits had to be met through
borrowings from the central government.
The FRBM Act envisaged complete phase out of
monetisation of deficits by RBI from 2006. Central
government budgetary deficits were to be met
through market borrowings. State governments
could borrow from market as well. FRBM
equivalents were proposed for state governments.
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MONETARY AND FISCAL POLICY FUNCTIONS
FISCAL POLICY
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The policy associated with
management of Government
spending based on tax and
non-tax revenues.
Involves policy with regard to
taxation (both direct and
indirect)
Involves policy with regard to
plan and non-plan
expenditures.
The key policy parameter is
about running the twin budget
deficits.
The key parameter monitored
is GDP growth and
employment.
MONETARY POLICY
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Involves management of supply of
money based on demand
parameters and economic
performance.
Central Banking uses both
quantitative tools as well as
monetary rate adjustments to
control supply of money.
Quantitative policy involves
increasing or decreasing central
bank money through OMO (RBI
does this through a window called
LAF), Reserve adjustments and
QE.
Rate adjustments involve
calibrating the Repo and Reverse
Repo rates.
The key parameters monitored are
inflation and GDP.
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REQUIREMENT FOR FRBM ACT
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The objectives of the Act as stated in the Statement of
Objects and Reasons were mainly (a) to curb
excessive deficits and bring in fiscal discipline and (b)
improve the financial health of the government. The Act
came into force from July 5, 2004 after the Ministry of
Finance issued the notification for the Act and the
FRBM Rules 2004 to come into force.
The Act proposed –
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to introduce transparent fiscal management system in the
country.
to introduce a more equitable and manageable distribution of
the country's debts over the years.
to aim for fiscal stability for India in the long run.
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MAIN PROVISIONS OF FRBM ACT
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The Act provides for –
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Phasing out Revenue Deficit from March 2008 (watered
down from 2006) by setting annual targets for reduction.
Reduction of annual fiscal deficit.
Annual targets for assuming contingent liabilities in the
form of guarantees and the total liabilities as a
percentage of the GDP.
Central Government not to borrow from RBI (section 5)
except under exceptional circumstances where there is
temporary shortage of cash in particular financial year.
Exceptions include national security, natural calamity or
other exceptional grounds that the Central Government
may specify. Post-facto approval from Parliament to be
obtained.
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MAIN PROVISIONS OF FRBM ACT
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The Act provides for (under section 3) the government to table on
an annual basis the following documents in the Parliament –
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Medium-term Fiscal Policy Statement - a three-year rolling target for the
fiscal indicators. This statement should also provide guidance on the
status of revenue deficit and whether the government’s capital receipts
would be usable for productive investment. Four specific disclosures
are - revenue deficit , fiscal deficit, tax revenue and total outstanding
liabilities (all expressed as a percentage of GDP.
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Fiscal Policy Strategy Statement – An annual statement detailing the
priorities for the ensuing financial year in taxation policy and fiscal
discipline within the objectives of the Act.
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Macro Economic Framework Statement – An annual Projection of
economic indicators such as GDP growth, revenue budget balance,
gross fiscal deficit, subsidies, administered pricing and external
account balance (balance of payments).
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MAIN PROVISIONS OF FRBM ACT
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The targets provided in the Act for various economic and
budgetary parameters (section 4 read with FRBM Rules
2004) –
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Annual targets for reduction of revenue deficit. Revenue deficit was
to be eliminated by March 2009. Minimum reduction in revenue
deficit is 0.5% of GDP.
Fiscal deficit to be brought down to 3% of GDP by 2008. Minimum
annual reduction 0.3% of GDP.
Max new debt obligations and guarantees to be capped at 9% of
GDP with progressive reduction of 1% every year to reach 6%.
Annual target of not more than 0.5% of GDP for assuming
contingent liabilities in the form of guarantees.
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WEAKNESSES IN THE ACT
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The central government formulates the rules for itself under
delegated legislation.
Exceptional circumstances under which the working of the Act
can be suspended are defined by the central government.
The actions of the central government under the Act are not
subject to the jurisdiction of civil courts.
The central government or any of its officers cannot be
prosecuted for actions performed under the Act.
No penal provisions for non-compliance. The Finance Minister to
only conduct quarterly reviews of the receipts and expenditures
of the Government and place these reports before the
Parliament. Deviations to targets set by the Central government
for fiscal policy have to be approved by the Parliament. No other
measures for failure of compliance have been specified.
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WORKING OF THE ACT
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The central government started off well by reducing the revenue
deficit to 1.1% and fiscal deficit to 2.7% of GDP. These measures
were suspended in the aftermath of the global financial crisis in
2008. The fiscal deficit rose to 6.2% in 2008-09, 4.9% in 201011, 5.9% in 2011-12 and is pegged at 5.1% for the current year
(a highly questionable target).
Revenue deficit was 4.4% for last FY and is pegged at 3.4% for
current year.
Indian government’s total debt (measured by debt-GDP% ratio)
fell under the Act from 75.8% in 2007 to 66.2% in 2011. However
it is still among the highest in the world. (Malaysia's 55.1, Pakistan's
54.1, the Philippines' 47, Thailand's 43.7, Indonesia's 25.4 and China's
16.5). The target for 2011-12 is 45.5% according to the Budget. A
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major portion comprises domestic debt owed to Indian banks,
insurance companies and the EPFO which could cause domestic
systemic crisis with no immediate external impact on the `.
External debt is about 15% of GDP out of which commercial
borrowings are about 5% of GDP.
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AMENDMENTS BY FINANCE ACT 2012
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Introduction of the concepts of ‘Effective Revenue Deficit’
and ‘Medium Term Expenditure Framework’ statement.
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Effective Revenue Deficit is the difference between revenue deficit
and grants for creation of capital assets. The government’s
justification is that it will help in reducing consumptive component
of revenue deficit and create space for increased capital spending.
Medium-term Expenditure Framework statement will set forth a
three-year rolling target for expenditure indicators.
Recommendations of the Expert Committees to streamline
and reduce the number of centrally sponsored schemes
and to address plan and non-plan classification to be kept
in view while implementing Twelfth Plan.
Central Plan Scheme Monitoring System to be expanded for
better tracking and utilisation of funds.
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OUTLOOK FOR 2013 AND BEYOND
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The key to FRBM implementation is the control of
government’s unproductive expenditure such as fertiliser
subsidy, oil pricing policy, free provision of goods and
services under various schemes, NREGA and other social
spending.
The increase in government spending without
corresponding investment and increase in supply side in the
past two years has led to steady core and headline inflation
and fall in GDP growth. Capital formation has remained
stagnant around 13% of GDP. This is despite the RBI’s
attempts to curb inflation with record number of rate
increases. Rate cuts can lead to spur in economic growth
and reduce fiscal deficit but can accentuate the present
inflation problem as well.
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OUTLOOK FOR 2012 AND BEYOND
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India’s external current account deficit is at record high of 5.4%
of GDP with a worsening BOP and pressure on the `. FDI has
been steadily falling and FY 2011-12 closed around $ 28 billion,
nowhere near the required FDI target of over $ 50 billion per year.
India’s net International Position is presently $ 272 billion and is
steadily declining. India has been financing import deficits with
capital inflows. Experts state that the real exchange rate is
presently ` 70-75 to a US$. The INR was the worst currency in
2012 in Asia.
India’s tax revenue is 51% of total budgetary receipts and is
pegged at a tax-GDP ratio of 10.6% for FY 2012-13. It is much
lower than in developed countries (UK 34%, Germany 37%, USA
24%). There is a case to increase tax base further than to impose
new taxes on the same tax payers.
Revenue targets could fall short - tax collections have picked up
but shortfall in disinvestment receipts anticipated.
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OUTLOOK FOR 2012 AND BEYOND
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Under the FRBM, the effective revenue deficit is pegged at
1.8% of GDP for 2012-13 (out of the total of 3.4%). As per
the amendments made by the Finance Act 2012, the
government shall strive to eliminate effective revenue
deficit by 2015 and bring revenue deficit to not more than
2% of GDP.
The government had reached 80% of fiscal deficit for 201213 by November. FM promises to contain to revised target
of 5.3% but it looks difficult.
Medium term challenges to FRBM mainly from reduced
growth and tax collections, rising expenditure-GDP ratio,
worsening external revenue deficit and persistent inflation.
Overall, the outlook for FRBM in the medium term is grim.
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FRBM FRAMEWORK – RECENT THOUGHT
PROCESS
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In Budget 2007, it was proposed by the Finance Minister to have a
separate Debt Management Office (DMO) for which the Public Debt
Management Agency of India Bill, 2012 was to be tabled in the
Parliament.
The idea behind separating the DMO from the RBI was to avoid conflict
of interest, as the RBI being the monetary policy authority might have a
bias towards a lower interest rate regime to reduce the cost of sovereign
debt even if it compromised its anti-inflationary stance.
The RBI was opposed to the move as it felt that when the budgetary
deficits are high, a separate DMO would cause arbitrary debt issuances
by the government without the involvement of RBI.
With the change of guard at MoF this proposal has been shelved.
Under the current framework, RBI is the debt manager of the
government under the provisions of the RBI Act.
Going forward increased divergence of views on FRBM account
expected. Proposal to make RBI completely autonomous by replacing
the RBI Act 1934 is also active. The present RBI Act provides for the
government as the overarching authority over RBI.
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THANK YOU
CA & CS Pratap G. Subramanyam
FCA,ACS
[email protected]