RBI calls for fiscal architecture overhaul

There is a need for reconciling the discrepancies between fiscal deficit and movement in debt in designing a meaningful framework on fiscal consolidation in India, according to a study by the Reserve Bank of India (RBI).

The paper, 'An Outline of Post 2009 FRBM Fiscal Architecture of the Union Government in the Medium Term', finds that the discrepancy between the two arises mainly due to factors like exclusion of off-budget liabilities and Market Stabilisation Scheme (MSS) in fiscal deficit while being part of outstanding liabilities, part of National Small Savings Fund (NSSF) being utilised by the states to finance their deficits being shown as liabilities of the central government, and financing of fiscal deficit by draw-down or build-up in cash balances. Particularly the off-budget liabilities, which arise due to securities issued to oil companies, Food Corporation of India and fertilizer companies are included in 'Other Accounts' of other liabilities, while the interest payments arising on these securities have an impact on the fiscal deficit, the issuance of these securities is excluded from the calculation of fiscal deficit, pointed out the study.

Accordingly, the paper attempts to reconcile the discrepancy and also reclassifies the expenditure components into current and investment component as against revenue and capital components in the Budget.

For the fiscal consolidation framework, interest payments (IP) to revenue receipts (RR) ratio consider the target variable, and based on budgetary identity, the study derives the tolerable level of deficit and debt under alternative assumptions of growth and interest rate. From the derived tolerable level of deficit, the components of expenditure are calibrated by making adjustments in the discretionary component.

Under alternative assumptions of growth, interest rate, revenue buoyancy and chosen ratio of targeted interest payments to revenue receipts (IP-RR), the paper generates a menu of choices on the path of fiscal consolidation during the medium term. The study provides simulated results of 54 alternative fiscal scenarios which may help in building a framework for post-2009 FRBM fiscal architecture.

The study says with the projection of 14% nominal growth of GDP, continuance of high revenue buoyancy, softening of the interest rate by 0.1 percentage points each year and the lenient target for IP/RR of 22% by 2013-14, the government would be able to run a deficit of close to 5.5% of GDP by 2013-14 and over 6.5% in the following year even when revenue receipts to GDP stop increasing and interest rate stops declining from the level of 2013-14.

By bringing down the current deficit to zero, the entire borrowing can be deployed for investment purposes, which would be higher than the base year level of 2007-08. A stiffer targeted reduction in IP/RR, however, would thereby reduce the tolerable level of deficit and debt significantly, said the study.

It clearly says that in the post-2009 FRBM period, the medium-term fiscal architecture implied by the target of 20% IP/RR appears to be challenging but achievable under normal expectations about future.

Moreover, the architecture based on the framework suggested provides the flexibility of incorporating the countercyclical fiscal policy stance if required in future to tackle the slowdown in the growth of the economy.

The then finance minister, P Chidambaram, in his budget speech of February 29, 2008, pointed explicitly to the need for looking into the fiscal architecture in the post-FRBM period. He declared that he would ask the 13th Finance Commission to do the needful. The Commission, in turn, asked the RBI to submit the study report.