Context

Kerala has announced an economic package of ?20,000 crore to mitigate the impact on livelihoods and overall economic activity from the sweeping steps taken to battle the COVID-19 pandemic and also urged the centre to provide flexibility under the FRBM Act.

Background:

• The novel coronavirus COVID-19 has created havoc with Kerala’s economy at a time when the state is limping back to normalcy after two consecutive state-wide floods in 2018 and 2019.
• A few months before the 2018 flood, there was first Okhi cyclone and then the Nipah virus outbreak in parts of the state.
• Despite these setbacks, the economy proved to be resilient because remittances from Non-Resident Keralites in Gulf (West Asia) did not decline.
• However, this year, the state’s revenues can go sharply down due to coronavirus effect at global level.

Analysis

What is the FRBM Act?

• Enacted in August 2003, the legislation is aimed at making the Central government responsible for ensuring “inter-generational equity in fiscal management and long-term macro-economic stability”.
• In other words, the current generation of the country’s administrators must ensure that their management of the country’s finances, both in terms of expenditure and revenue, does not leave future generations saddled with the burden of having to service unsustainably high levels of inherited debt that would in turn affect their ability to provide a stable economic environment for contemporary society.
• To achieve this, the Act envisages the setting of limits on the Central government’s debt and deficits as well as mandating greater transparency in fiscal operations of the Central government and the conduct of fiscal policy in a medium-term framework.
• The rules for implementing the Act were notified in July 2004 and since then every Budget of the Union government has included a Medium Term Fiscal Policy Statement that specifies the annual revenue and fiscal deficit goals over a three-year horizon.
• The government also uses the Budget to spell out the longer-term glide path to achieve the key objective of reducing the fiscal deficit to 3% of GDP within a specified time frame — one that has shifted from the initial goal of March 31, 2009, to March 31, 2021, when the rules were amended in 2018, and most recently to the setting of a target of 3.1% for March 2023.
• To ensure that the States too are financially prudent, the 12th Finance Commission’s recommendations in 2004 linked debt relief to States with their enactment of similar laws.
• The States have since enacted their own respective Financial Responsibility Legislation, which sets the same 3% of Gross State Domestic Product (GSDP) cap on their annual budget deficits.
  
  

Why does the state want flexibility under the FRBM?

• During the financial year 2020-21, Kerala can borrow around Rs 25,000 crore.
• However, as the state proposes to raise a big amount of debt in the very first month of the new financial year, the state government is concerned that the stringent borrowing cap under the fiscal responsibility laws should not constrain its borrowing and spending ability over the remaining 11 months.
• In the upcoming months, the state needs fund to continue with COVID-19 mitigation measures.
• It would also have to meet other expenditures for routine affairs related to the running of the State’s socio-economic programmes as well as the post pandemic recovery.
  
  

Can relaxation of the FRBM help?

• The FRBM Act contains an ‘escape clause’.
• Under Section 4(2) of the Act, the Centre can exceed the annual fiscal deficit target citing grounds that include national security, war, national calamity, collapse of agriculture, structural reforms and decline in real output growth of a quarter by at least three percentage points below the average of the previous four quarters.
• Given that the ongoing pandemic could be considered as a national calamity — which in conjunction with the ongoing lockdown to combat it is in all likelihood going to cause a severe contraction in economic output as well — the current circumstances would be apt for suspending both the Centre’s and States’ fiscal deficit targets.
• This would allow both the Union government and States including Kerala to undertake the much-needed increases in expenditure to meet the extraordinary circumstances.
  
  

Learning from the past:

• There have been several instances of the FRBM goals being reset.
• Most recently, presenting the Budget for 2020-21 in February, Finance Minister Nirmala Sitharaman had cited the recent reductions in corporate tax as structural reforms that would trigger the escape clause enabling the government to recalibrate the fiscal deficit target for 2019-20 to 3.8%, from the budgeted 3.3%.
• The spillover impact of the reforms would also necessitate a reset for 2020-21: from the earlier deficit target of 3% to 3.5%.
• But the most significant FRBM deviation happened in 2008-09, in the wake of the global financial crisis, when the Centre resorted to a focused fiscal stimulus: tax relief to boost demand and increased expenditure on public projects to create employment and public assets, to counter the fallout of the global slowdown.
• This led to the fiscal deficit climbing to 6.2%, from a budgeted goal of 2.7%.
• Simultaneously, the deficit goals for the States too were relaxed to 3.5% of GSDP for 2008-09 and 4% of GSDP for fiscal 2009-10.
• The precedents are there and given the unprecedented nature of the pandemic and its devastating impact on the global economy, another significant deviation from the FRBM norms is very likely in the current and next fiscal years.
  
  

The way forward:

For any country, the costs of not adhering to fiscal deficit targets can be substantial. The years after global financial crisis, when India did not adhere to the envisaged path of fiscal consolidation, were associated with macroeconomic instability, pushing the economy to the brink during the ‘taper tantrum’ crisis of 2013. But when economic activity is going through a lean patch and there isn’t enough demand, it may become necessary to use fiscal policy to engineer a revival.