Fiscal Policy ,Explained

Fiscal Policy ,Explained


What is Fiscal Policy?

Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation’s economy.

It is that part of the government policy which is concerned with raising revenue through taxation and deciding on the amount and purpose of the government spending.

It deals not only with the quantity of funds but also the quality of public finance.

What is Fiscal Deficit?

Fiscal Deficit is the difference between the government earnings and its spending. It is the difference between what is received by the government on revenue account and all the non debt creating capital receipts.

Fiscal Deficit = Total government expenditure – Revenue Receipts – Non Debt Creating Capital Receipts

What is Fiscal Consolidation?

Fiscal Consolidation refers to the strengthening of government finances. It helps the government to cut down on wasteful expenditure and enables it spend more on social sector and infrastructure.

Effective fiscal consolidation has allowed India to emerge as a preferred investment destination. This has been a result of strength of its policy and institutional frameworks.

Various measures and decisions that have contributed to fiscal consolidation in India are:

E-auctioning of natural resources,

a rule-based framework for Indian monetary policy,

Insolvency and Bankruptcy code,

Introduction of the Goods and Services Tax (GST),

Other aspects of conduct of fiscal policy which have played an important role in contributing towards improving India’s growth and investment potential include:

Restraint on unproductive spending,

Plugging of subsidy leakage through implementation of the Direct Benefits Transfer (DBT),

Higher devolution of revenue to States and local self-governments,

Greater autonomy to States for spending on developmental plans,

Guidelines under the Fiscal Responsibility and Budget Management Act (FRBM).


What is FRBM Act?

FRBM Act was first introduced in India in December 2000 to bring down the increasing government deficits both at the Centre and in the States.

It was enacted in 2003 to institutionalise fiscal discipline, by seeking to eliminate revenue deficit and to bring down fiscal deficit to a manageable 3 per cent of GDP by Financial Year 2008-09.

Objectives of FRBM Act

Fiscal discipline

Increasing planned expenditure

Reduction in amount of borrowings

To meet the consumption from government’s own fiscal resources

Give autonomy to Reserve Bank of India (RBI) for money creation


Reforms in FRBM Act

In the light of current domestic and global dynamics, a committee has been formed to review the FRBM Act. Certain changes which could be made in the FRBM Act considering the contemporary needs are as follows:

Adoption of a ‘Point based’ and appropriate fiscal deficit target:

A point based target infuses fiscal discipline.

It limits the room for government trying too many things.

It also provides an unambiguous signal to the bond markets.

Such a target will lead to focused policy communication and subsequently help in ratings upgrade for India.

A favourable economic atmosphere will lower the cost of borrowing for the private sector and aid new capital and investment formation.

Rules serving as  guiding principles:

Effective rule-based policy would help the governments adopt a countercyclical approach and limit the scope for creative accounting which involves capitalizing on loopholes in the accounting standards to falsely portray a better image of the company.

A ‘spending rule’ with a medium-term debt range and due consideration to institutional setting could enhance the policy credibility, allow effective monitoring and ensure stability, fairness and efficiency.

A ‘debt sustainability rule’ can help in implementing a ceiling on government debt. This will also allow India to act as per the Maastricht Treaty guidelines.

An ‘expenditure rule’ that focuses on improving the quantity and quality of spending and improve accountability could be chosen.

Independent constitutional body as a watchdog:

FRBM Act should provide for an independent reviewer or a Fiscal Council, to oversee the adoption of rule-based fiscal policy and also recommend future course of action.

A well-designed fiscal council with strict operational independence will boost fiscal accountability and transparency and also contribute in enhancing the ratings of India.

To Sum up

Adoption of FRBM 2.0 framework will enhance the efficacy of India’s fiscal policy and significantly reduce the twin-deficit vulnerability. At a time when most developed economies are struggling with their government’s fiscal management efficiency, a rule-based system with room for independent advisory and oversight can transform India’s fiscal architecture and promote investment in India at a major scale.


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