concerned over the worsening of fiscal situation, in 2000, the Government of India had set up a committee to recommend draft

legislation for fiscal responsibility. Based on the recommendations of the Committee, Government of India introduced the Fiscal Responsibility and Budget Management (FRBM) Bill in December 2000. In this Bill numerical targets for various fiscal indicators were specified. The Bill was referred to the Parliamentary Standing Committee on Finance. The Standing Committee recommended that the numerical targets proposed in the Bill should be incorporated in the rules to be framed under the Act. Taking into account the recommendations of the Standing Committee, a revised Bill was introduced in April 2003. The Bill was passed in Lok Sabha in May 2003 and in Rajya Sabha in August 2003. After receiving the assent of the President, it became an Act in August 2003. The FRBM Act 2003 was further amended.

Image Credits Rob Kroenert. The FRBM Bill / Act provides rules for fiscal responsibility of the Central Government. The FRBM Act 2003 (as amended) became effective from July 5, 2004. Under this Act, Rules are framed relating to fiscal responsibility of the Central Government, which came into force on 5th July 2004.

Objectives of FRBM Act 2003

The main objectives of FRBM Bill / Act are :1. To reduce fiscal deficit

2. To adopt prudent debt management. 3. To generate revenue surplus.

Features of FRBM Act 2003

1. Revenue Deficit

The first important feature of Amended FRBM bill 2000 or FRBM Act 2003 is that the central government should take certain specific measures related with reduction of revenue deficit. Measures relating to reduction of revenue deficits are:1. The government should reduce revenue deficit by an amount equivalent to 0.5 percent or more of the GDP at the end of each financial year, beginning with 2004-2005. 2. The revenue deficit should be reduced to zero within a period of five years ending on March 31, 2009. 3. Once revenue deficit becomes zero the central government should build up surplus amount of revenue which it may utilised for discharging liabilities in excess of assets.

2. Fiscal Deficit

The second important feature of Amended FRBM bill 2000 or FRBM Act 2003 is that the central government should take certain specific measures related with reduction of fiscal deficit. Measures relating to reduction of fiscal deficits are:1. The government should reduce Gross fiscal deficit by an amount equivalent to 3.3% or more of the GDP at the end of each financial year, beginning with 2004-2005. 2. The central government should reduce Gross Fiscal deficit to an amount equivalent to 2% of GDP upto March 31 2006.

3. Exceptional Grounds

The third important feature of Amended FRBM bill 2000 or FRBM Act 2003 is that it clearly stated that the revenue deficit and fiscal deficit of the government may exceed the targets specified in the rules only on the grounds of national security or national calamity faced by the country.

4. Public Debt

The fourth important feature of Amended FRBM bill 2000 or FRBM Act 2003 is that the central government should ensure that the total liabilities (including external debt at current exchange rate) should not exceed 9% of GDP for the financial year 2004-2005. There should be progressive reduction of this limit by atleast one percentage point of GDP in each subsequent year.

5. Borrowing from the RBI

The fifth important feature of Amended FRBM bill 2000 or FRBM Act 2003 is related with borrowings done by central government from R.B.I. The Amended FRBM bill 2000 or FRBM Act 2003 clearly states that the central government shall not normally borrow from the R.B.I. However the central government may borrow from R.B.I. by way of advances to meet temporary excess of cash payments over the cash receipts during any financial year in accordance with the agreements which may entered into by the government with the R.B.I.

6. Fiscal Transparency

The sixth important feature of Amended FRBM bill 2000 or FRBM Act 2003 is related with fiscal transparency. The Amended FRBM bill 2000 or FRBM Act 2003 clearly stated two important measures to ensure greater transparency in fiscal operations of the government. These two important features are as follows :1. The central government should minimize as far as possible secrecy in preparation of annual budget.

2. The central government at the time of presentation of the annual budget shall disclose the significant changes in accounting standards, policies and practices likely to affect the computation of fiscal indicators.

7. Limit On Guarantees

The seventh important feature of Amended FRBM bill 2000 or FRBM Act 2003 is that it restricts the guarantees given by the central government to 0.5% of GDP in any financial year beginning with 2004-2005.

8. Medium term fiscal policy statement

The eighth important feature of amended FRBM bill 2000 or FRBM Act 2003 is that the central government should present medium term fiscal policy statement in both houses of parliament along with annual financial statement. The medium term fiscal policy statement should project specifically for important fiscal indicators. These fiscal indicators are as follows :1. 2. 3. 4. Revenue deficit as percentage of GDP. Fiscal deficit as percentage of GDP. Tax revenue as percentage of GDP. Total outstanding liabilities as percentage of GDP.

9. Compliance of rules

Finally the ninth important feature of Amended FRBM bill 2000 or FRBM Act 2003 is related with measures to enforce compliance of rules. These measures are as follows :1. The FRBM bill clearly states that the Finance Minister shall review every quarter, the trends in receipts and expenditure in relation with the budget and place it before both houses of parliament the outcome of such reviews. 2. The finance minister shall also make statement in both houses of parliament if there is any deviations in meeting the obligations of the central government. 3. If deviations are substantial then the Finance Minister will declare the remedial measures which the central government proposes to take in future period of time.

4. The rules mandate the central government to take appropriate corrective action in case of revenue & fiscal deficit exceeding 45% of the budget estimates or total non-debt receipts falling short of 40% of the budget estimates at the end of first half of the financial year.

10. Task force on implementation of FRBM Act

Following the enactment of FRBM Act, Government constituted a Task Force headed by Dr. Vijay Kelkar for drawing up the medium term framework for fiscal policies to achieve the FRBM targets. The task force proposed the following measures :1. Widening the tax base through removal of exemptions. 2. An All-India goods and service-tax (GST) on the basis of a "grand bargain" with States, whereby States will have the concurrent powers to tax service, subject to certain principles that will help foster a national common market. 3. Income tax exemption limit to be increased to Rs.1,00,000. 4. A two-tire rate structure of 20 percent tax for income of Rs. 1,00,000 to Rs. 4,00,000 and 30% for income above Rs. 4,00,000 for individuals and elimination of standard deduction available to the salaried taxpayer. 5. A reduction in the corporate income tax to 30% for domestic companies and the reduction in depreciation rates from 25 to 15%. 6. A 3-tier custom duty rates of 5, 8 and 10% to bring down tariffs to ASEAN levels. 7. Allocation of greater portion of expenditure to legitimate public goods by revisiting the classification of expenditure. 8. Empowering panchayats / local bodies through reserve transfer. The task force stated that under the reforms measures recommended by it, tax GDP ratio of the central government should be raised from 9.2% in 2003 to 13.2% of GDP in 2008-09. A revenue surplus of 0.2% of GDP is estimated to emerge in 2008-09. Fiscal deficit estimated to fall from 4.8% of GDP in 2003-04 to 2.8% of GDP in 2008-09. The above features of Amended FRBM bill 2000 or Fiscal Responsibility and Budget Management Act 2003 clearly points out that the government intends to create a strong institutional mechanism to restore fiscal discipline at the level of the central government. Similarly the government wants to introduce greater transparency in fiscal operations of the central government.

Criticism / Limitations of FRBM Act 2003

Though the Fiscal Responsibility and Budget Management Act 2003 or Amended FRBM bill 2000 is a credible effort by the government to fix responsibility on the government to reduce fiscal deficit and bring transparency in fiscal operations of the government it has certain limitations. These limitations of Amended FRBM Bill 2000 or FRBM Act pointed out by various economists are as follows :-

1. Target regarding GFD very stringent

The Bill stipulates that by March 31, 2006, the Gross Fiscal Deficit (GFD) as a proportion of GDP must be 2%. This, of course, means that the government can borrow from the economy only to the extent of 2% of GDP, whatever be the level of savings. Given the present need of government borrowings, 2% limit is very low. The increase in public investment helps to increase the level of effective demand and increases private investment in the economy. According to Dr. Raja Chelliah the ratio of Gross Fiscal Deficit (GFD) to GDP should be 4% to 5% of GDP as public investment on infrastructure sector is essential to boost economic growth.

2. Neglect of equity and growth

According to critics the Amended FRBM Bill 2000 or FRBM Act 2003 is heavily loaded against investment in both human development and infrastructure sector. One of the major ommission of amended FRBM Bill 2000 or FRBM Act 2003 was complete absence of any target for time bound minimum improvement in areas of power generation, transport, etc. which is very important both from the point of equity and higher economic growth.

3. Non-Coverage of State Governments

The provisions of the bill impose restrictions on only the central government but state governments are out of its scope. But, deficits of state governments are as much or even a greater problem. For instance, the State of Maharashtra has already crossed the deficit of Rs. 1 lakh

crore as on December 2004 (the second State after Up to cross deficit of Rs. 1 lakh crore). Therefore, there is a need for fiscal responsibility legislation for the State Governments as well.

4. Neglect of Development Needs

Today, the levels of capital expenditures by the government are miserably low in India. These capital expenditures increase the efficiency and productivity of private investment and thus contribute to the development process in the country. If Revenue Deficit is to be reduced to zero and GFD to be 2% of GDP as per the requirement of FRBM Bill, it is the capital expenditure which will be sacrificed and thus will hinder further development of the country.

5. Need to Increase Revenue

Revenue deficits are determined by the interplay of expenditure and revenues, both tax and nontax. Too often, attention gets focused only on the expenditure side of the identity to the neglect of the revenue side. Increasing non-tax revenue requires that public sector services be appropriately priced, which may be difficult as the present society has got used to the subsidised education, health, food items, etc.

6. Neglect of Social Sector

The FRBM bill does not mention anything relating to social sector development. However, investment in social sector such as health, education, etc is very vital for the economic development of the nation.

7. Problem of Subsidies

The government may be able to reduce revenue deficit by reducing subsidies. However, it is quite likely that the government will be under severe pressure to continue the subsidies. It means the expenditure on the productive areas may be reduced due to subsidies.

8. Stable Growth Deficit

Chelliah points out that given the household financial savings in India, the overall fiscal deficit termed as stable growth deficit of the government sector as a whole should be pegged at 6% of GDP with revenue deficit being gradually phased out. Thus, the target of 2% of fiscal deficit GDP ratio stated in FRBM bill is not desirable from the point of view of productive investment according to Chelliah.

9. False Assumptions

The FRBM Bill is based on the following assumptions :1. Lower fiscal deficit lead to higher growth. 2. Larger fiscal deficit lead to higher inflation 3. Larger fiscal deficit increase external vulnerability of the economy. These assumptions have been rejected by C.P. Chandrashekhar and Jayanti Ghosh who have given the following arguments :1. If the deficit is in the form of capital expenditure it would contribute to future growth. 2. Fiscal deficit is not only the cause for higher inflation. During the late 1990s the rate of inflation has fallen even when the fiscal deficit was as high as 5.5% of GDP. 3. Higher fiscal deficit need not necessarily cause external crisis. The external vulnerability depends more on capital and trade account convertibility. In India we have managed to build large foreign exchange reserves, though fiscal deficit has not come down.

Conclusion on FRBM Act 2003

The Amended FRBM Bill 2000 or FRBM Act 2003 despite above criticism can play a very important role in controlling fiscal deficit and in bringing transparency in fiscal operation of the government if it is implemented effectively in letter and spirit by the concerned government.

FISCAL POLICY VS MONETARY POLICY

I. THE BUSINESS CYCLE Market economies have regular fluctuations in the level of economic activity which we call the business cycle. It is convenient to think of the business cycle as having three phases. The first phase is expansion when the economy is growing along its long term trends in employment, output, and income. But at some point the economy will overheat, and suffer rising prices and interest rates, until it reaches a turning point -- a peak -- and turn downward into a recession (the second phase). Recessions are usually brief (six to nine months) and are marked by falling employment, output, income, prices, and interest rates. Most significantly, recessions are marked by rising unemployment. The economy will hit a bottom point -- a trough -- and rebound into a recovery (the third phase). The recovery will enjoy rising employment, output, and income while unemployment will fall. The recovery will gradually slow down as the economy once again assumes its long term growth trends, and the recovery will transform into an expansion. II. ECONOMIC POLICY AND THE BUSINESS CYCLE The approach to the business cycle depends upon the type of economic system. Under a communist system, there is no business cycle since all economic activities are controlled by the central planners. Indeed, this lack of a business cycle is often cited as an advantage of a command economy. Both socialist and fascist economies have a mix of market and command sectors. Again, the command sector in these economies will not have a business cycle -- while the market sector will display a cyclical activity. In a full market economy -- like the United States -- the nation can suffer extreme swings in the level of economic activity. The economic policies used by the government to smooth out the extreme swings of the business cycle are called contracyclical or stabilization policies, and are based on the theories of John Maynard Keynes. Writing in 1936 (the Great Depression), Keynes argued that the business cycle was due to extreme swings in the total demand for goods and services. The total demand in an economy from households, business, and government is called aggregate demand. Contracyclical policy is increasing aggregate demand in recessions and decreasing aggregate demand in overheated expansions. In a market economy (or market sector) the government has two types of economic policies to control aggregate demand -- fiscal policy and monetary policy. When these policies are used to stimulate the economy during a recession, it is said that the government is pursuing expansionary economic policies. And when they are used to contract the economy during an overheated expansion, it is said that the government is pursuing contractionary economic policies. III. FISCAL POLICY AND MONETARY POLICY Fiscal policy is changes in the taxing and spending of the federal government for purposes of expanding or contracting the level of aggregate demand. In a recession, an expansionary fiscal policy involves lowering taxes and increasing government spending. In an overheated expansion,

a contractionary fiscal policy requires higher taxes and reduced spending. According to Keynes, a recession requires deficit spending while an overheated expansion requires a budget surplus. 1) Discretionary Fiscal Policy. The first way this can be done is through the federal budget process. However, this process takes so long -- 12 to 18 months -- that it is difficult to match discretionary fiscal policy with the business cycle. The expansionary Kennedy tax cut of 1964 and later the contractionary Ford tax increase of 1974 hit the economy just when the opposite contracyclical policy was needed. As a result, the federal government will only use discretionary fiscal policy in a severe recession, such as 1981-82 and 2008-09. In both cases, the federal government resorted to a large fiscal stimulus tax cuts in 1981-82 and increased spending in 2008-09. Both policies created large deficits, which is the appropriate stabilization policy during a severe downturn. 2) Automatic Stabilizers. A second type of fiscal policy is built into the structure of federal taxes and spending. This is referred to as "nondiscretionary fiscal policy" or more commonly as "automatic stabilizers". The progressive income tax (the major source of federal revenue) and the welfare system both act to increase aggregate demand in recessions, and to decrease aggregate demand in overheated expansions. These automatic changes in spending and taxes will generate a deficit in recessions and a surplus in overheated expansions. The size of these automatic changes can be quite large. In the 2008-09 recession the deficit stimulus due to the automatic stabilizers was much larger than the stimulus created by the legislative changes in taxes and spending (discretionary fiscal policy). Monetary policy is under the control of the Federal Reserve System (our central bank) and is completely discretionary. It is the changes in interest rates and money supply to expand or contract aggregate demand. In a recession, the Fed will lower interest rates and increase the money supply. In an overheated expansion, the Fed will raise interest rates and decrease the money supply. These decisions are made by the Federal Open Market Committee (FOMC) which meets every six to seven weeks. The policy changes can be done immediately, although the impact on aggregate demand can take several months. Monetary policy has become the major form of discretionary contracyclical policy used by the federal government. A source of conflict is that the Fed is independent and is not under the direct control of either the President or the Congress. This independence of monetary policy is considered to be an important advantage compared to fiscal policy. Note that expansionary monetary policy is commonly called "easy money" while contractionary monetary policy is called "tight money". Other terms are also used.