FRBM Committee Recommends Glide Path To Bring Fiscal Deficit Down To 2.5%

A committee set up to review the fiscal framework for the Indian economy recommended that the central government's fiscal deficit be brought down to 2.5 percent over the next six financial years and that revenue deficit be contained at levels under 1 percent by then. The committee also recommended a target for government debt with separate ceilings for central and state government debt.

The committee headed by former Revenue Secretary NK Singh submitted its report to the government ahead of the Union Budget 2017-18 in February. The report of the committee was made public on Wednesday. Committee members included Reserve Bank of India Governor Urjit Patel, Chief Economic Adviser Arvind Subramanian, Sumit Bose and Rathin Roy. Subramanian submitted a dissent note and advocated a looser fiscal policy to suit India's growth needs.

The key recommendations of the committee revolve around bringing down government debt to 60 percent of GDP by fiscal 2023. To do this, the fiscal deficit should be adopted as the key operational target, said the committee.

The committee suggests that the fiscal deficit be held steady at 3 percent between fiscal 2018 and fiscal 2020. From here on, a steady reduction to 2.5 percent by fiscal 2023 has been suggested. The government is yet to say whether the committee's recommendations will be accepted or not. However, for the current fiscal, the government is targeting a fiscal deficit of 3.2 percent – higher than the 3 percent recommended by the committee.

A large part of the fiscal deficit contraction should come from the revenue deficit, suggested the committee. In keeping with that philosophy, a steeper contraction in the revenue deficit is being proposed. The government should bring down the revenue deficit to 0.8 percent of GDP by fiscal 2023 from 2.3 percent in fiscal 2017, the committee said.

The proposed decline in revenue and fiscal deficit should help bring down central government debt to 38.7 percent of GDP over this time period. The overall cap for government debt has been set at 60 percent of GDP, with 20 percent being earmarked for states.

The Fiscal Responsibility And Budget Management (FRBM) Act would need to be repealed, should the government choose to accept these targets.

The Escape Clause

Along with the glide path to reduce government debt and deficit, the committee has suggested an ‘escape clause' that the government can invoke in times of economic stress. If this escape clause is invoked, the government can exceed the stipulated deficit for the year by up to 0.5 percentage points. RBI Governor Urjit Patel disagreed with the committee on the quantum of the escape clause and suggested a lower deviation of 0.3 percentage points.

The clause can be invoked in the following circumstances:

• Over-riding consideration of national security, acts of war; calamities of national proportion and collapse of agriculture severely affecting farm output and incomes.
• Far-reaching structural reforms in the economy with unanticipated fiscal implications.
• Sharp decline in real output growth of at least 3 percentage points below the average for the previous four quarters.

On the flip side, if growth is stronger than expected, the government is expected to bring its fiscal deficit down to below the stipulated levels. This is to ensure that a government used good times to strengthen its fiscal position.

The committee has also recommended that a fiscal council be set up. The three-member council would entirely consist 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.

If the government were to accept the committee's recommendations, it could potentially invoke the escape clause for fiscal 2018 since reform measures, such as the Goods and Services Tax (GST) could be considered ‘structural reforms' which will impact government finances. However, Finance Minister Arun Jaitley, while presenting his Budget speech, had said that the escape clause has not yet been invoked.

Subramanian's Dissent Note

The committee's report includes a dissent note from Chief Economic Adviser Arvind Subramanian, who has called for looser fiscal policy for some time now. In his note, Subramanian calls the targets set by the committee as “arbitrary.”

Instead, Subramanian proposes one target – to eliminate the general government primary deficit over a five-year period. This would ensure a declining trajectory for government debt, which would reassure investors and ensure that India's debt remains sustainable. The primary deficit is defined as fiscal deficit minus interest payments.