Explained: Off-Budget Financing

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.