Coronavirus | Why has Kerala sought a relaxation of Fiscal Responsibility and Budget Management rules?

When can norms of the FRBM Act be flexible? How will it help?

The story so far: Kerala was one of the earliest States to announce an economic package of ₹20,000 crore to mitigate the impact on livelihoods and overall economic activity from the sweeping steps taken to battle the COVID-19 pandemic, including the latest 21-day nationwide lockdown. Explaining the rationale for the package, Chief Minister Pinarayi Vijayan wrote in the The Hindu (March 27, 2020): “While we enforce the lockdown in all its seriousness, we should not lose sight of the other major challenge in front of us. India has a high share of poor in its population, most of whom suffer from multiple economic and social deprivations. They earn their livelihoods from the informal and unorganised sectors, where there is neither job security nor continuity of income flows. Their livelihoods have to be protected through the lockdown period.” To help fund the emergency relief package, the State proposes to borrow as much as ₹12,500 crore from the market in April itself and the Chief Minister has urged the Centre to provide Kerala with flexibility under the Fiscal Responsibility and Budget Management (FRBM) Act so as to ensure that the State’s finances are not adversely impacted in the rest of the financial year starting on April 1.

What is the FRBM Act?

Enacted in August 2003, the legislation is aimed at making the Central government responsible for ensuring “inter-generational equity in fiscal management and long-term macro-economic stability”. In other words, the current generation of the country’s administrators must ensure that their management of the country’s finances, both in terms of expenditure and revenue, does not leave future generations saddled with the burden of having to service unsustainably high levels of inherited debt that would in turn affect their ability to provide a stable economic environment for contemporary society. To achieve this, the Act envisages the setting of limits on the Central government’s debt and deficits as well as mandating greater transparency in fiscal operations of the Central government and the conduct of fiscal policy in a medium-term framework. The rules for implementing the Act were notified in July 2004 and since then every Budget of the Union government has included a Medium Term Fiscal Policy Statement that specifies the annual revenue and fiscal deficit goals over a three-year horizon. The government also uses the Budget to spell out the longer-term glide path to achieve the key objective of reducing the fiscal deficit to 3% of GDP within a specified time frame — one that has shifted from the initial goal of March 31, 2009, to March 31, 2021, when the rules were amended in 2018, and most recently to the setting of a target of 3.1% for March 2023.

To ensure that the States too are financially prudent, the 12th Finance Commission’s recommendations in 2004 linked debt relief to States with their enactment of similar laws. The States have since enacted their own respective Financial Responsibility Legislation, which sets the same 3% of Gross State Domestic Product (GSDP) cap on their annual budget deficits.

Why is Kerala seeking flexibility under the FRBM?

Kerala’s current fiscal position means that it can borrow about ₹25,000 crore during the financial year 2020-21. Now, given that it proposes to raise half that amount of debt in the very first month of the new financial year, the State government is understandably concerned that the stringent borrowing cap under the fiscal responsibility laws should not constrain its borrowing and spending ability over the remaining 11 months — a period when it would not only need to continue with its COVID-19 mitigation measures but would also have to meet other expenditure for routine affairs related to the running of the State’s socio-economic programmes as well as the post pandemic recovery.

How does a relaxation of the FRBM work?

The law does contain what is commonly referred to as an ‘escape clause’. Under Section 4(2) of the Act, the Centre can exceed the annual fiscal deficit target citing grounds that include national security, war, national calamity, collapse of agriculture, structural reforms and decline in real output growth of a quarter by at least three percentage points below the average of the previous four quarters.

Given that the ongoing pandemic could be considered as a national calamity — which in conjunction with the ongoing lockdown to combat it is in all likelihood going to cause a severe contraction in economic output as well — the current circumstances would be apt for suspending both the Centre’s and States’ fiscal deficit targets. This would allow both the Union government and States including Kerala to undertake the much-needed increases in expenditure to meet the extraordinary circumstances.

When have the FRBM norms been relaxed in the past?

There have been several instances of the FRBM goals being reset. Most recently, presenting the Budget for 2020-21 in February, Finance Minister Nirmala Sitharaman had cited the recent reductions in corporate tax as structural reforms that would trigger the escape clause enabling the government to recalibrate the fiscal deficit target for 2019-20 to 3.8%, from the budgeted 3.3%. The spillover impact of the reforms would also necessitate a reset for 2020-21: from the earlier deficit target of 3% to 3.5%.

But the most significant FRBM deviation happened in 2008-09, in the wake of the global financial crisis, when the Centre resorted to a focused fiscal stimulus: tax relief to boost demand and increased expenditure on public projects to create employment and public assets, to counter the fallout of the global slowdown. This led to the fiscal deficit climbing to 6.2%, from a budgeted goal of 2.7%.

Simultaneously, the deficit goals for the States too were relaxed to 3.5% of GSDP for 2008-09 and 4% of GSDP for fiscal 2009-10.

The precedents are there and given the unprecedented nature of the pandemic and its devastating impact on the global economy, another significant deviation from the FRBM norms is very likely in the current and next fiscal years.

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