Fiscal Federalism - Fiscal Federalism refers to the division of responsibilities with regards to public

expenditure and taxation between the different levels of the government. The Government of India
Act 1919 and 1935 formalized the tenets of fiscal federalism and revenue sharing between the
Centre and the states. It allows the government to optimize their costs on economies. The
Constitution has provided provisions which enable the Union and the States to work in coordination
and to levy and collect these taxes through systematic arrangements, provisions like below is a
measure of fiscal federalism.

1) Taxes levied and collected by the Centre but assigned to the States.

2) Taxes levied by the Centre but collected and kept by the States.

3) Taxes levied and collected by the States.

4) Taxes levied and collected by the Local Governments

Local Public Finance – the creation of an Urban Local Body (ULB) or the Panchayati Raj institutions
consolidated fund is an important step towards fiscal federalism. Centre and States should
contribute an equal proportion of their Central GST (CGST) and State GST (SGST) collections and send
the money to the consolidated fund of the third tier. One-Sixth sharing of the CGST and SGST with
the third tier can generate more than 1% of the GDP every year for the financing of public goods by
urban-level bodies. State Finance Commissions should be accorded the same status as the Union
Finance Commission and the 3Fs of democratic decentralization (funds, functions, and functionaries)
should be implemented properly. GST should be simplified in its structure and by ensuring: Single
Rate GST: with suitable surcharges on sin goods, zero ratings of exports and reforming the
Integrated Goods and Services Tax (IGST) and the e-way bill. GST is a comprehensive, multi-stage,
destination-based tax that is levied on every value addition. GST is one indirect tax for the entire
country. The GST council is the key decision-making body that will take all important decisions
regarding the GST. The GST Council should undertake reforms in an informed and transparent
manner, by creating its own secretariat and independent experts.

The FRBM Act - Fiscal Responsibility and Budget Management Act (FRMBA) was introduced in
Parliament as the FRBM Bill, by the then finance minister, Yashwant Sinha, in December 2000. The
Bill, was approved by the Union Cabinet in 2003, and it became effective from July 5, 2004. The
Fiscal Responsibility and Budget Management Act (FRBM Act), 2003, establishes financial discipline
to reduce (central) fiscal deficit. The Preamble to the FRBM Act 2003 sheds light on some of its key
features. The scheme of the paper, has six sections. Section II briefly reviews literature on the
FRBMA. Section III examines cross-country experiences and Section IV highlights historical
developments pertaining to FRBMA. Section V discusses the need for review of the Act, and Section
VI presents trend analysis. Finally, Section VII concludes the paper with certain recommendations.

Objectives of the FRBM Act?

1) To establish and foster financial discipline in the economy.

2) Reduction of fiscal deficit to not more than 3% of GDP.

3) Keeping the volume of public debt under 40% of GDP by 2024.

4) Efficient management of tools of fiscal policy - expenditure, revenue and debt.

5) Achieving a balanced budget and generating budget surpluses.

The Act seeks to achieve:

1) The FRBM Act aims to introduce transparency in India's fiscal management systems.

2) The Act’s long-term objective is for India to achieve fiscal and macroeconomic stability.

3) To give the Reserve Bank of India (RBI) flexibility to deal with inflation in India.

4) The FRBM Act was enacted to introduce more equitable distribution of India's debt over the
years.

5) Debt management and maintain its sustainability. 6) Limiting borrowings to cut down deficits and
debt.

Key features of the FRBM Act - The FRBM Act made it mandatory for the government to place the
following along with the Union Budget documents in Parliament annually: 1) Medium Term Fiscal
Policy Statement 2) Macroeconomic Framework Statement 3) Fiscal Policy Strategy Statement The
FRBM Act proposed that revenue deficit, fiscal deficit, tax revenue and the total outstanding
liabilities be projected as a percentage of Gross Domestic Product (GDP) in the medium-term fiscal
policy statement.

Criticism of the FRBMA: On grounds of national security, calamity, etc, the set targets of fiscal
deficits and revenue could be exceeded. Several years have passed since the FRBM Act was enacted,
but the Government of India has not been able to achieve targets set under it. The Act has been
amended several times. The implementation of FRBM Act has been stalled four times since its
enactment in 2003. With more than a decade of experience, including regular pauses, there was a
critical need to evaluate the implementation of provisions of FRBMA. Since FRBMA enactment in
2003, its role has been discussed continuously in controlling fiscal and revenue deficit. Despite its
existence, the fiscal deficit has been on the rise, the framework has not been delivered and
budgetary compliance has not happened. Recently, a special FRBM Committee submitted a report
on its findings to the Finance Minister. Finally, the report was made public in April 2017. The
accounts of central and state governments in India are frequently audited by the Comptroller and
Auditor General of India (CAG), which is a constitutional authority formed to undertake audits of all
the receipts and expenditures of the government. However, the accounts of cities in the country
rarely get audited.

FRBM Act exemptions – In 2013, the government introduced a change in the FRBMA and introduced
the concept of effective revenue deficit. This implies that effective revenue deficit would be equal to
revenue deficit minus grants to states for the creation of capital assets. In 2016, a committee under
N K Singh was set up to suggest changes to the Act. According to the government, the targets set
under FRBM Act previously were too rigid. The Central Government introduced a medium-term
fiscal adjustment road map on March 16, 2012 to improve fiscal situation at federal level. The
concept of effective revenue deficit was introduced, which excluded grants to states for creation of
capital assets from conventional revenue deficit. The second important feature was the introduction
of provision for 'Medium Term Expenditure Framework Statement’ in the FRBMA. This medium-term
framework provides for rolling targets for expenditure, imparting greater certainty, and encourages
prioritization of expenditure.

Latest on MRBM Act – Fiscal deficit is the negative balance that arises whenever a government
spends more money than it receives in the form of taxes and other revenues. The number is one of
the most keenly observed figures during the budget. It assumes significance especially now as the
ongoing Covid-19 pandemic has necessitated government to undertake many measures to uplift a
sluggish economy. The pandemic has necessitated taking recourse to the escape clause [section 4(2)]
of the FRBM Act, thus allowing an additional fiscal deficit of 0.5 per cent of GDP. Former RBI
governor Bimal Jalan said, “there is an FRBM target, which is a bit outdated and that was set, several
years ago. Hence, we should not worry about that part because economic matters are changing over
time. He added that the fiscal deficit of 6.8% is actually not very high and we can expect that the rate
of inflation will be within control.” The government has always been criticized for not being
transparent with the deficit numbers. Writing for TOI, leading economist SA Aiyar said: "We need a
budget for truth, forgiveness and reconciliation. For too long the truth about the government’s
spending and borrowing has been hidden by layers of financial fudging. Such fudging has been done
by all political parties.

Public Debt Sustainability and Related Issues - Public debt has been one of the major causes of
financial crises in several emerging markets across the world. Poorly structured debt in terms of
maturity, undefined or incorrect currency or interest rate composition and large and unfunded
contingent liabilities have been important factors in indulging economic crisis in many countries. In
the macroeconomic context government should seek to ensure that both the level and rate of
growth in their public debt is fundamentally sustainable. In case of India, less attention has been
paid to the level, cost and structure of India's overall public debt, both domestic and external. India’s
traditional concerns have been with fiscal deficits (both Centre and state) and with the size and
maturity of the country's external debt. In India fiscal sustainability got importance during the late
80s, with sharp fiscal deterioration both at national as well as sub-national levels. India’s
government debt grew first with the 1991 fiscal balance of payments crisis, and then again after
1997-98, when fiscal deficits became 10 per cent of GDP range. To make the economic growth
sustainable with macroeconomic stability, reducing public debt is a critical component. When the
government borrows to finance a looser fiscal position, the greater demand for loan able funds can
reduce private investment (and other interest sensitive components of private spending) by raising
interest rates. Under a floating exchange rate, higher interest rates will also tend to attract foreign
capital, leading to an appreciation of the exchange rate, which will also crowd out exports.
Government of India enacted Fiscal Responsibility and Budget Management (FRBM) Act in 2003 on
the presumption that fiscal imbalance is the key parameter adversely affecting all other
macroeconomic variable. This aims at reducing debt to GDP ratio. Apart from FRBM Act, from time
to time the Government of India has taken fiscal initiatives to inculcate fiscal discipline or to achieve
debt sustainability. Considering the importance of debt sustainability, it is essential to analyse the
debt sustainability of India. Debt sustainability has been assessed in terms of numerous indicators
analysis. Traditionally effort has been directed towards developing indicators to measure
sustainability.

1) Buiter (1985) in his paper, “A guide to public sector debts and deficits defined a sustainable fiscal
policy should maintain the ratio of public sector net worth to output at its current level.

2) Blanchard (1990) explained two conditions for sustainability first, the ratio of debt to Gross
National Product (GNP) should eventually converge back to its initial level and secondly, present
discounted value of the ratio of primary surplus to Gross National Product should be equal to
current level of debt to GNP.

3) Blanchard et al. (1990) explained debt level to be sustainable if a country’s debt to GDP ratio
remains stable under double digit figure and if the economy generates debt stabilizing primary
balance to cover that debt in future.