A Post-COVID Fiscal Framework

Context: The worrisome economic prospect after the COVID has prompted calls for the Fiscal Responsibility and Budget Management Act (FRBM) to be dusted off, reintroduced, and implemented.

 

Critically Analyzing the conventional ways to improve debt sustainability in India:

• Keep Primary Balance (PB) > Interest-growth differential: For maintaining a broadly stable debt ratio. But this is no longer possible because-
  • Higher interest rates may now be needed to convince investors to hold a greater amount of debt. 
  • Not easy to push PB to surplus to compensate for unfavourable interest-growth differential.
• Setting up a framework like Fiscal Responsibility and Budget Management Act (FRBMAct), 2003: To set strict limits on fiscal deficits, both for the centre and the states.
  • But this framework will not work as per our experience: Apart from the initial period, when growth was booming, the deficit targets were largely honoured in the breach, leaving the PB essentially unchanged (Figure 2, phase 2).

Post-Covid fiscal framework for India: Government should adopt a strategy based on the following principles;

• Ensure debt sustainability: The emphasis on achieving sustainability, rather than a specific debt ratio. 
• Abandon multiple fiscal criteria: for guiding fiscal policy.
  • The current FRBM sets targets for the overall deficit, the revenue deficit, and debt. This proliferation of targets can conflict with each other, creating confusion about which one to follow and thereby obfuscating accountability.
• The framework should not be fixated on specific numbers: Around the world, countries are realizing that deficit targets of 3% of GDP and debt targets of 60% of GDP lack proper economic grounding.
  • Centre should not set out yearly targets for the primary balance. Instead, it should announce a plan to improve the primary balance gradually.
  • Example: Say, improve half a percentage point of GDP per year on average, making clear that it will accelerate consolidation when times are good, moderate it when times are less buoyant, and end it when a small surplus has been achieved.
  • Flexibility in annual policies depending on the state of the economy and an end-point consistent with the overall objective.
• Learn and adapt: COVID has upended India’s public finances. It is time to learn from past experiences and adapt. Adopting a simple new fiscal framework along the lines, we have proposed could be the way forward.