Setting up of a committee to look into the merits of having flexible fiscal deficit targets, in sync with the prevailing economic conditions, has received positive reactions from stakeholders. The proposed committee would review the working of the decade-old Fiscal Responsibility and Budget Management (FRBM) Act that presently binds both the Central and state governments to adhere to the pre-determined fiscal deficit targets. This leaves no room for the government to boost growth with more public spending. But, with uncertainty and volatility becoming the new norms of the global economy, “the time has come to review the working of the FRBM Act,” said Finance Minister Arun Jaitley while mooting the idea of such a committee during his Budget speech.
Instead of fixed targets, it may be better to have a fiscal deficit range as the target, which would give necessary policy space to the government to deal with dynamic situations, added the minister. Analysts often espouse the conventional rule which says that the government’s spending should be relaxed in times of slowdown while it should be curtailed during prosperous times to help the economy take advantage of lower interest rates. “Such fiscal flexibility is required to preserve growth in trying economic conditions,” says D.K. Joshi, chief economist with Crisil. The only assumption is that government would exercise such flexibility with utmost care while remaining committed to the overall fiscal consolidation path. Experts say that over the years, especially since early 2000s, India’s successive governments have shown a deep faith in fiscal prudence.
Experts, however, caution that such fiscal flexibility works well only when it is supported by a well calibrated monetary policy. So, if the government spends more by borrowing more from the capital markets then the RBI should be keeping interest rates tight to offset the inflationary impact of the loose fiscal policy. Such an approach by the RBI might seem anti-growth but is advisable to keep inflationary tax in check.
The fiscal rigidity to follow the pre-determined deficit targets was institutionalised by Yashwant Sinha in 2003 when he was the finance minister under the previous NDA rule. Having a rule-based approach was deemed urgent as India as a nation had been living beyond its means by spending more on consumption (subsidies) rather than on creating durable assets in the economy. The move was deeply appreciated by stakeholders as India faced a huge embarrassment when the nation’s gold was pledged during the 1990-91 balance of payment crisis. So, Sinha got this act enacted to control the populist tendencies of the government. The Act provided for annual reduction targets for fiscal indicators.