Centre, States Must Act In Partnership To Strengthen Fiscal Fundamentals: NK Singh

As India moves towards a new fiscal framework, the Centre and states will need to act together to bring down the country's debt to more comfortable levels and reduce the fiscal funding gap. NK Singh, who chaired a committee reviewing the Fiscal Responsibility and Budget Management (FRBM) Act, told BloombergQuint that such a partnership would be essential to bring down the country's debt-to-GDP ratio to the suggested 60 percent by 2023.

The report of the six-member FRBM review committee, submitted to the government in January, was made public earlier this month. Apart from suggesting an overall cap, the committee recommended that the Centre's debt-to-GDP ratio be restricted to 40 percent while states stick to an aggregate debt-to-GDP ratio of 20 percent.

This could prove to be a challenge at a time when state finances are seen deteriorating. Singh, however, said it is essential to control both state and central government finances as external agencies tend to look at the aggregate while judging a country's fiscal standing.

After a period of consolidation, state finances started to look shaky in fiscal 2017. The fiscal deficit for 16 states widened to 3.4 percent in fiscal 2017 compared to 3.1 percent the previous year, highlighted a report by Kotak Institutional Equities released on Tuesday. Gross borrowings from these states rose to Rs 3.4 lakh crore in fiscal 2017 compared to Rs 2.6 lakh crore in the previous year.

Singh acknowledged that state finances have had a ‘checkered past' and added that upcoming Fifteenth Finance Commission should look into the inter se division of debt between states.

Singh added that the ‘information asymmetry' between individual state finances and their borrowing costs needs to be removed.

At present, the market tends to price all state borrowings at a similar spread above the central government's borrowing rate. Investors do not distinguish between well-run states and those that are running large deficits or have high debt. If this were to change, states would be under greater pressure to adhere to a path of fiscal prudence.

Arbitrary Targets?

One criticism of the NK Singh committee's recommendations came from within the committee itself. Chief Economic Adviser Arvind Subramanian, who has called for looser fiscal policy for some time now, said in a dissent note that the targets set by the committee are “arbitrary.”

“A 60 percent debt-GDP rule cannot command broad consensus,” wrote Subramanian while adding that the medium term fiscal deficit target of 2.5 percent of GDP is “based on a conceptual framework that is unrelated to the debt objective and based on calculations that are hard to justify.”

Subramanian also argued that the primary deficit ought to be the principal anchor for fiscal policy.

Singh, in response, said that a number of countries around the world have now adopted debt as the anchor for fiscal policy and added that the framework has received international acceptance. “Hardly any worthwhile country today is adopting a primary deficit really as a principal anchor,” said Singh.

Also Read: India's New Fiscal Framework: Are We Choosing The Right Targets?

An Independent Fiscal Council

The FRBM review committee has also suggested the setting up of an independent fiscal council.

The three-member council would consist entirely of government appointed members. It's main task would be to “provide an independent assessment of the central government's fiscal performance and compliance with targets” set under the revised Act. The government would also be expected to consult with the fiscal council before invoking the escape clause, which allows it to expand the fiscal deficit by upto 0.3 percent of GDP to deal with stress or structural reforms which impact government revenue.

The council is expected to function as an advisory body and is not intended to “trump” the government in any form, said Singh. The council's advice need not be binding on the government, he added.

The recommendations of the committee are still to be formally accepted by the government.