What is Fiscal Responsibility?
Fiscal responsibility implies a government pursues the appropriate level of government spending and tax to:
- Maintain sustainable public finances.
- Ensure fiscal policy aids the optimal rate of economic growth.
- Maintain appropriate levels of public investment.
The ultimate idea is to keep rising levels of debt in check and to ensure economy does not breakdown due to burden from excess borrowing.
Fiscal stimulus is used to support the economy in the times of economic crisis which leads to an increase in government deficits and increased government debt.
Fiscal Responsibility and Budget Management (FRBM)
Fiscal Responsibility and Budget Management (FRBM) became an Act in 2003. The objective of the Act is to ensure inter-generational equity in fiscal management, long run macroeconomic stability, better coordination between fiscal and monetary policy, and transparency in fiscal operation of the Government.
The Government notified FRBM rules in July 2004 to specify the annual reduction targets for fiscal indicators. The FRBM rule specifies reduction of fiscal deficit to 3% of the GDP by 2008-09 with annual reduction target of 0.3% of GDP per year by the Central government. Similarly, revenue deficit has to be reduced by 0.5% of the GDP per year with complete elimination to be achieved by 2008-09. It is the responsibility of the government to adhere to these targets. The Finance Minister has to explain the reasons and suggest corrective actions to be taken, in case of breach.
FRBM Act provides a legal institutional framework for fiscal consolidation. It is now mandatory for the Central government to take measures to reduce fiscal deficit, to eliminate revenue deficit and to generate revenue surplus in the subsequent years. The Act binds not only the present government but also the future Government to adhere to the path of fiscal consolidation. The Government can move away from the path of fiscal consolidation only in case of natural calamity, national security and other exceptional grounds which Central Government may specify.
Further, the Act prohibits borrowing by the government from the Reserve Bank of India, thereby, making monetary policy independent of fiscal policy. The Act bans the purchase of primary issues of the Central Government securities by the RBI after 2006, preventing monetization of government deficit. The Act also requires the government to lay before the parliament three policy statements in each financial year namely Medium Term Fiscal Policy Statement; Fiscal Policy Strategy Statement and Macroeconomic Framework Policy Statement.
FRBM amendment in 2012
Concept of “Effective Revenue Deficit” and “Medium Term Expenditure Framework” statement arc two important features of amendment to FRBM Act in the direction of expenditure reforms. Effective Revenue Deficit (discussed previously) will help in reducing consumptive component of revenue deficit and create space for increased capital spending. “Medium-term Expenditure Framework” statement set forth a three- year rolling target for expenditure indicators.