A counterbalancing force?

Post the pandemic, a section of policymakers has yet again argued for the creation of a fiscal council that would provide independent forecasts on macro-variables such as GDP growth and tax buoyancy, and oversee compliance with debt targets. It is claimed that the Fiscal Responsibility and Budget Management (FRBM) Review Committee (The NK Singh committee 2017) recommended the creation of a fiscal council in line with global practices, which will also bring transparency in the budget process. Similar recommendations were also proposed by the 13th and 14th finance commissions, which advocated the establishment of independent fiscal agencies to review the government's adherence to fiscal rules, and to provide independent assessments of budget proposals.

Context

Though Article 293 provides a Constitutional check over the borrowings by the state government, there is no such restriction on the Central government. The FY22 budget omitted any talk of the debt-to-GDP ratio even in the 'Medium Term Fiscal Policy Cum Fiscal Policy Strategy Statement', though the finance ministry through an amendment to the FRBM Act in FY19 had included it as the key fiscal target, promising to bring it down to 60 per cent by FY25, reported The Print. But during the last two years it has reached around 80 per cent.

The Fiscal Responsibility and Budget Management (FRBM) committee headed by former revenue secretary NK Singh had mandated states to achieve a debt-to-GSDP ratio of 20 per cent by FY 2022-23. However, in a report in November 2021, the Reserve Bank of India (RBI) highlighted that the debt-to-GSDP ratio for 18 states and union territories has grown to 31.2 per cent from 22.6 per cent in the last 10 years, ending September 2021.

A recent IMF working paper (January, 2022, no WP/22/11) titled 'Fiscal Rules and Fiscal Councils: Recent Trends and Performance during the COVID-19 Pandemic' has argued that the adoption of fiscal rules and fiscal councils continued to increase globally over the last decades. According to the study, during the pandemic, fiscal frameworks were put to test. The widespread use of escape clauses was one of the novelties in this crisis, which helped provide the policy room to respond to the health crisis. But the unprecedented fiscal actions have led to large and widespread deviations from deficit and debt limits. The study mentions that the fiscal rules, in general, have been flexible during crises but have not prevented a large and persistent build-up of debt over time.

The paper also gives evidence on the benefits of a good track record in abiding by the rules and highlights the difficult policy choices and needs to further improve the rules-based fiscal frameworks. It presented an overview of fiscal rules and fiscal councils across the world in the run-up to and during the COVID-19 pandemic. The study relied on newly updated global datasets on fiscal rules and fiscal councils during 1985–2021.The findings illustrate the diverse experiences with rules-based fiscal frameworks.

While advanced economies were frontrunners in adopting fiscal rules, these rules are increasingly becoming common among emerging market and developing economies (EMDEs). There were 51 fiscal councils in 49 countries as of 2021, about twice the number in 2010. Many of them were established to monitor the new fiscal rules or in response to external pressures after large shocks. Deficits and debt in many countries surged during the pandemic, leading to large deviations from fiscal rule limits. About 90 percent of countries had deficits larger than the rule limits in 2020, while public debt exceeded the limits or anchor levels in over half of countries, adding to already large pre-COVID deviations.

The IMF report reveals that the fiscal councils it has studied, have a considerable diversity of institutional forms. Most are attached to the legislative branch (parliamentary budget offices), the executive, or operate as stand-alone entities. Parliamentary budget offices have historically emerged in presidential political systems such as in Korea and the United States. They have spread in various forms such as in Australia, Canada, Georgia, and Mexico. Fiscal councils attached to the executive include those in Belgium, Croatia, the Netherlands, and the United Kingdom. Fiscal councils in two countries (France and Finland) are attached to the supreme audit institution. Stand-alone entities are more common among recently established fiscal councils as they often emanate from comprehensive Fiscal Responsibility Laws (Czech Republic, Slovak Republic, Sweden).

What is a Fiscal Council?

IMF (2013) defines Fiscal councils as independent public institutions aimed at promoting sustainable public finances through various functions, including public assessments of fiscal plans and performances, and the evaluation or provision of macroeconomic and budgetary forecasts. By fostering transparency and promoting a culture of stability, they can raise reputational and electoral costs of undesirable policies and broken commitments.

Fiscal councils are often non-partisan, technical bodies entrusted as a public finance watchdog to strengthen credibility of fiscal policies with a variety of mandates. IMF defines fiscal rules as a long-lasting constraint on fiscal policy through numerical limits on budgetary aggregates. Fiscal rules typically aim at correcting distorted incentives and containing pressures to overspend, particularly in good times, so as to ensure fiscal responsibility and debt sustainability.

The IMF paper claimed that all else equal, fiscal councils can promote stronger fiscal discipline as long as they are well-designed. It also pointed to a number of key features of effective fiscal councils — a strict operational independence from politics, the provision or public assessment of budgetary forecasts, a strong presence in the public debate (notably through an effective communication strategy), and an explicit role in monitoring fiscal policy rules.

As early as 2011, OECD published a paper arguing strongly in favour of the Fiscal Council. After the recession of 2008, there was a growing interest in the role of independent fiscal institutions, or fiscal councils, in helping to improve fiscal performance. OECD defined a fiscal council as a publicly-funded entity staffed by non-elected professionals mandated to provide nonpartisan oversight of fiscal performance and/or advice and guidance – from either a positive or normative perspective – on key aspects of fiscal policy.

It argued that a fiscal council can contribute to improved fiscal performance in a variety of ways. By depoliticising various aspects of fiscal policy, whether related to formulation or monitoring, fiscal councils can better inform voters on the actual state of fiscal policy and raise the political costs of fiscal indiscipline.

A fiscally responsible government may wish to create a fiscal council to solidify the credibility it has already gained. Conversely, absent political will, there are no assurances that a new institution such as a fiscal council will help. OECD in their report quoted von Hagen (2010): "Fiscal councils may be helpful to strengthen the credibility of medium-term fiscal rules, but only in cases where the government has considerable commitment power to begin with." Thus, a fiscal council could be either an additional mechanism where strong political commitment is present, or ineffective where it is not.

A key question surrounding the decision to create a fiscal council is why such an entity would have a potentially greater disciplining effect than existing unofficial and academic bodies or persons?

It is argued that in smaller countries with a relatively less-developed infrastructure of unofficial bodies, the creation of a fiscal council enables the pooling of local expertise (creating analytical synergies) and access to financial and informational resources not otherwise available to unofficial bodies. And in larger countries, however, where unofficial bodies are prevalent and potentially influential through the media and by active participation in public policy debates, a principal advantage gained from the creation of a fiscal council is the latter's access to the more detailed confidential data normally restricted to legislative and executive agencies. In all countries, however, a desired benefit to the government of creating an official fiscal council is to signal the government's commitment to good behaviour.

Fiscal architecture of India

The three pillars of the fiscal architecture are: fiscal rules, public financial management (PFM) processes, and fiscal institutions. Over the years, India has created all the three pillars which are very strong.

(i) General Financial Rules (GFR) were issued for the first time in 1947, bringing together in one place all existing orders and instructions pertaining to financial matters. These have subsequently been modified and issued as GFR 1963, GFR 2005 and GFR 2017. GFRs are a compilation of rules and orders of Government of India to be followed by all while dealing with matters involving public finances. These rules and orders are treated as executive instructions to be observed by all Departments and Organisations under the Government and specified bodies except otherwise provided for in these Rules.

In the last few years, the Government has made many innovative changes in the way it conducts its business. Reforms in Government budgeting, like removal of distinction in non-plan and plan expenditure, merger of Railway Budget with General Budget, focusing on outcomes through an improved Outcome Budget document, all needed to be reflected in the GFRs. Increased focus on Public Finance Management System (PFMS), reliance on the Direct Benefit Transfer (DBT) Scheme to ensure efficient delivery of entitlements, introduction of new e-sites like Central Public Procurement Portal, Government e-Marketing (GeM) Portal, Non-Tax Revenue Portal have also necessitated revision of the existing GFRs to keep them in tune with the changing business environment. The objective was to make the GFRs facilitate efficiency rather than create impediments in smooth and timely implementation while following principles of accountability and procedures of financial discipline and administrative due diligence.

The Expenditure Management Commission, set up in 2014 to recommend ways in which efficiency of public expenditure could be increased, has also made several recommendations, especially with respect to Autonomous Bodies. In GFR 2017, new rules on non-tax revenues, user charges and e-receipts portal have been added in addition to the manner in which Autonomous Bodies are run.

(ii) India's current public financial management (PFM) processes are defined at the highest level in the Constitution itself. State and Union governments submit their respective budgets in the Assemblies and the Parliament for discussion and approval. Comptroller and Auditor General (CAG) — a Constitutional body — submits its reports to the Parliament on a regular interval. Since 2009, the Public Financial Management System (PFMS) — a web-based online software application developed and implemented by the Controller General of Accounts (CGA), Department of Expenditure, Ministry of Finance — has been introduced with the objective of tracking funds released under all Plan schemes of Government of India, and real time reporting of expenditure at all levels of Programme implementation. Subsequently, the scope was enlarged to cover direct payments to beneficiaries under all Schemes.

In addition to these, one important institution which is an integral part of India's financial architecture is the Finance Commission, a constitutional body that determines the method and formula for distributing the tax proceeds between the Centre and states, and among the states, as per the Constitutional arrangement and present requirements. The Finance Commission also decides the share of taxes and grants to be given to the local bodies in states. This part of tax proceeds is called Finance Commission Grants, which is a part of the Union budget.

Under the Article 280 of the Constitution, the President of India is required to constitute a Finance Commission at an interval of five years or earlier. Under Article 281 of the Constitution, the President of India is required to cause the laying of the Finance Commission report before each House of Parliament along with an explanatory note and the action taken by the government on the Commission's recommendations. The 73rd Constitutional Amendment Act of 1992 created the Panchayati Raj institutions as the third level of a three-tier democratic governance system at the village level, intermediate level and district level. It also mandated the constitution of a Finance Commission every five years by state governments to decide the division of resources (tax proceeds) between a state government and Panchayati Raj institutions at all levels.

To manage budgetary deficits, the Fiscal Responsibility and Budget Management (FRBM) Bill was introduced in the Parliament in the year 2000. The primary aim was to give a legal backing to the fiscal discipline. Enacted in 2003, it had set targets for the government to reduce fiscal deficits. Calculated as a percentage of its GDP, fiscal deficit is the total money spent by the government in excess of its income. The FRBM Act mandated the Central government to bring down its fiscal deficit to three per cent of the GDP.

The initial deadline to reach the 3 per cent target was 2007-08 but it has been extended several times over the years. In 2018, the deadline was again extended to 2020-21. However, in the FY21 Budget, the target was relaxed to 3.5 per cent as permitted under the FRBM Act. The Centre made use of escape clauses to deviate from the fiscal consolidation roadmap. The option allows the government to widen the deficit by 0.5 percentage points in times of exigencies such as a war or calamities of national proportion.

Because of higher expenditure and lower revenues on account of COVID-19, the number in FY21 came in at 9.3 per cent of the GDP. To enable the fiscal deficit beyond the permissible limit, the government amended the FRBM Act in the Finance Bill last year. The Centre is targeting to gradually bring down the deficit to below 4.5 per cent in the next four years, reported Business Standard.

(iii) The Financial Institutions in India mainly include the Central Bank which is better known as the Reserve Bank of India, the commercial banks, the credit rating agencies, the securities and exchange board of India, insurance companies and the specialised financial institutions in India. The Reserve Bank of India was established in 1935 with a view to organise the financial framework and facilitate fiscal stability in India. The bank acts as the regulatory authority with regard to the functioning of the various commercial banks and the other financial institutions in India.

Conclusion

India has a well-established fiscal architecture built on three strong pillars. Possibly the government is planning to establish a fiscal council to 'signal government's commitment to good behaviour'. Logically a fiscal council may act as a fourth pillar of the financial architecture, provided it is established as a Constitutional entity like the GST Council. But a publicly funded fiscal council, staffed by non-elected professionals, would erode the Constitutional responsibility of the Finance Ministers who are elected members of the Parliament/Assemblies. Such a Fiscal Council will weaken the federal and democratic architecture of the existing public financial management (PFM) process of India.

Views expressed are personal