The Monday Page
Understanding the FRBM Act
The Centre has breached the 45% limit of revenue deficit for the first half of the financial year prescribed by theFiscal Responsibility and Budget Management (FRBM) Rules. As per the Rules, Union finance minister PChidambaram will have to make a statement in Parliament during the ongoing winter session, explaining the reasons for the breach and the corrective steps proposed.
takes a closer look at what is the FRBM Act and why it isimportant.
What is the FRBM Act?
The FRBM Act was enacted by Parliament in 2003 to bring in fiscal discipline. It received the Presidents assent inAugust the same year. The United Progressive Alliance (UPA) government had notified the FRBM Rules in July 2004.As Parliament is the supreme legislative body, these will bind the present finance minister P Chidambaram, and alsofuture finance ministers and governments.
How will it help in redeeming the fiscal situation?
The FRBM Rules impose limits on fiscal and revenue deficit. Hence, it will be the duty of the Union government tostick to the deficit targets.As per the target, revenue deficit, which is revenue expenditure minus revenue receipts, have to be reduced to nil in fiveyears beginning 2004-05. Each year, the government is required to reduce the revenue deficit by 0.5% of the GDP.The fiscal deficit is required to be reduced to 3% of the GDP by 2008-09.It would mean reduction of fiscal deficit by0.3 % of GDP every year.
How are these targets monitored?
The Rules have mid-year targets for fiscal and revenue deficits. The Rules required the government to restrict fiscal andrevenue deficit to 45% of budget estimates at the end of September (first half of the financial year).In case of a breach of either of the two limits, the FM will be required to explain to Parliament the reasons for thebreach, the corrective steps, as well as the proposals for funding the additional deficit.
What is fiscal deficit?
Every government raises resources for funding its expenditure. The major sources for funds are taxes and borrowings.Borrowings could be from the Reserve Bank of India (RBI), from the public by floating bonds, financial institutions,banks and even foreign institutions. These borrowings constitute public debt and fiscal deficit is a measure of borrowings by the government in a financial year.In budgetary arithmetic, it is total expenditure minus the sum of revenue receipts, recoveries of loans and other receiptssuch as proceeds from disinvestment.
Do economies need a fiscal deficit?
Many economists, including Lord Keynes, had advocated the need for small fiscal deficits to boost an economy,especially in times of crises. What it means is that government should raise public investment by investing borrowedfunds. This exercise is also called pump-priming. The basic purpose of the whole exercise is to accelerate the growth of an economy by public intervention. Hence, there is nothing fundamentally wrong with a fiscal deficit, provided the costof intervention does not exceed the emanating benefits.The darker side of the story is that the borrowed funds, which always remain on tap, have to be repayed. And pending