Mains Paper 3: Economy | Mobilization of resources
From UPSC perspective, the following things are important:
Prelims level: Fiscal deficit, Off-Budget financing, FRBM Act,
Mains level: Deficit Financing Mechanisms
What’s the issue?
- The Comptroller and Auditor General (CAG) of India has pulled up the government for increased use of off-budget financing for schemes and subsidies in its Compliance of the Fiscal Responsibility and Budget Management (FRBM) Act report for FY17.
- This practice of off- budgeting masks the true extent of fiscal and revenue deficits.
- The CAG of India recommended that the government to institute a policy framework for off-budget financing, which, should include a disclosure about its rationale and objective to parliament.
Why in news?
- In terms of revenue spending, off-budget financing was used for covering the fertilizer bills through special banking arrangements; food subsidy bills of the Food Corporation of India through borrowings.
- And for implementation Accelerated Irrigation Benefits Programme, govt. borrowed from the NABARD under the Long Term Irrigation Fund.
- Such off-budget financing are not part of calculation of the fiscal indicators despite fiscal implications.
Explained: Off-Budget Financing
- This refers to expenditure that’s not funded through the budget.
- For example, the government sets up a special purpose vehicle (SPV) to construct a bridge.
- The SPV will likely borrow money to build the bridge on the strength of a government guarantee.
- If it’s not a toll bridge, the SPV will need government support to meet interest obligations.
Why is it Problematic?
- Even though the borrowing and spending is outside the budget, it has implications for the budget and for all practical reasons should be included in that document.
- Since it’s not, this doesn’t reflect on the fiscal deficit number as well.
- Governments across the world use this to escape budget controls.
Implications of Off-budget financing
- Off-budget financing by its nature isn’t taken into account when calculating fiscal indicators.
- But the cost is borne by the budget through some mechanism or the other.
- Such financing tends to hide the actual extent of government spending, borrowings and debt and increase the interest burden.
- In the above example, the borrowing by the SPV should ideally be included in the government’s debt.
- To the extent that this spending is backed by a government guarantee, it entails a fiscal risk.
- Hence, Parliamentary control on such spending is also reduced as its remains outside the budget.
CAG favors a Policy for Disclosure
- In order to address these issues, CAG said the government should consider putting in place a policy framework for off-budget financing.
- The framework should specify the rationale and objective of off-budget financing, quantum of off-budget financing and sources of fund, among others.
- CAG further said the government should also consider disclosing the details of off- budget borrowings through disclosure statements in Budget as well as in accounts.
Fiscal Responsibility and Budget Management (FRBM) Act
- 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
- FRBM became an Act in 2003 which provides a legal-institutional framework for fiscal consolidation.
- The 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 a breach.
- 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.
- The Act prohibits borrowing by the government from the Reserve Bank of India, thereby, making monetary policy independent of fiscal policy.