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Fiscal discipline in India
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ABSTRACT
The present study broadly attempts to analyze the role of Fiscal Responsibility and Budget
Management Act in restoring fiscal balance in India. It analyses the need for fiscal rules and
constraints in India. The study aims at finding out the major factor behind rising fiscal imbalance
in India and to examine whether there is an electoral motive towards high fiscal deficit to GDP
ratio or not. It also analyzes the effectiveness of various measures undertaken at the central and
state level to inculcate fiscal discipline in the fiscal management. The study also makes an
attempt to do a critical in depth reviews of the Fiscal Responsibility and Budget Management
Act and make an attempt at examining effectiveness and suitability of FRBM Act through a
quantitative analysis. It also makes an attempt to suggest improvements in the fiscal monitoring
mechanism in India. We employ Ordinary Least Square (OLS) method to examine the impact of
Fiscal Responsibility and Budget Management Act on fiscal deficit in India using the data for the
period 1980-81 to 2008-09. The regression results indicates that FRBM Act does not have a
significant effect on the Gross Fiscal Deficit (GFD) to GDP ratio where as GDP (at factor cost)
growth rate has a significant negative effect on the GFD to GDP ratio.
Introduction
Fiscal policy rule is defined as a permanent constraint on fiscal policy expressed in terms of a
summary of fiscal performance, such as the budget deficit, borrowing, debt or a major
component thereof (Kopits and Symansky, 1998). The need for fiscal policy rule arises due to the
impact of the fiscal policy on stabilization and growth objectives, the sustainability of the fiscal
policy stance, and the linkages between fiscal and other policy instruments. Loose fiscal policy,
especially when financed by printing money, can lead to high and volatile inflation.
Rationale for Fiscal Responsibility in India
In India rationale for fiscal policy rule is in part attributable to the deterioration in fiscal
performance. India has done a tremendous economic growth within these two decades. Its GDP
growth rate has become 9 percent but its sustainability has been in question, first with the 1991
fiscal-balance of payments crisis, and then again after 1997-98, when fiscal deficits became 10
percent of GDP range and government debt grew. High deficit, unproductive expenditure and
tax distortion have constrained the economy from realizing its full growth potential. To make
this economic growth sustainable with macroeconomic stability, fiscal policy rule is a critical
component (Economic survey, 2007).
RBI Attempts towards Controlling Borrowing
In September 1994 an agreement (without legislated sanction) was signed between the central
government and the Reserve Bank of India (RBI) to phase out the system of ad-hoc treasury bills
by 1997- 98. Adhoc treasury bills facilitated automatic monetization of the budget deficit. This
adhoc Treasury bill was replaced with Ways and Means Advances.
Medium Term Fiscal Reform Programs (MTFRPs)
In 2000-01 the finance ministry issued guide lines to state for Medium Term Fiscal Reform
Programs (MTFRPs). The MTFRP had dual aim of reducing wasteful expenditure (cutting low
priority spending) and improving tax collection or improving the efficiency of the tax
administration. The MTFRPs required the state to make time bound reform in four areas like,
fiscal, power and public sector and budgetary. The main objective of MTFRPs were to bring the
consolidated fiscal deficit to sustainable levels by 2005 and to bring down debt-GDP ratio as well
as interest payment to revenue expenditure rate over the medium term. The MTFRPs finalized
for nine states, namely Nagaland, Andhra Pradesh, Karnataka, Orissa, Kerala, Arunachal Pradesh,
West Bengal, Himanchal Pradesh and Manipur. Despite the operation of Fiscal Reform Facilities
(FRFs) state achieved 6.23 percent reductions in Revenue Deficit/Revenue Receipt ratio by 2002-
03 as against the targeted 15 percent reduction over the base year 1999-00. In 2003-04, the
position deteriorated by 1.89 percent. The aggregate fiscal deficit of state actually increased
from 2.35 percent of GDP in 1993-94 to 3.5 percent in 2004-05. Similarly state revenue deficit
increased marginally from 0.45 percent of GDP in 1993-94 to 1 percent of GDP in 2004-05. The
outstanding debt to GDP ratio of state increased substantially from 21.79 percent of GDP in
1993-94 to 31.15 percent in 2002-03.