Governance Now Visionary Talks Series

Fiscal responsibility laws in the time of Covid-19

How to find the sweet spot between stimulus and stability as nations stare at long-term challenges to economy

Pratik Kumar | May 2, 2020


#fiscal responsibility   #economy   #lockdown   #healthcare   #epidemic   #coronavirus   #COVID-19   #FRBM Act  
Farmers tending to the crop amid the lockdown (Photo: PIB)
Farmers tending to the crop amid the lockdown (Photo: PIB)

At a time when countries around the globe are trying to save human lives from the Novel Coronavirus outbreak, addressing other issues, for example, containing the economic distress caused by it, is also a major challenge before them. As an easy way, most of them have responded with an infusion of relief packages into the economy. No doubt, this step is rightly aimed at reviving the economy in the post-lockdown phase, but concerns about swelling fiscal deficit in public accounts due to it is another harsh fact. Therefore, apart from different challenges in accomplishment of their objective through such packages, one set of laws needs serious consideration in such policy enactments – the fiscal responsibility laws.

Maintenance of the fiscal discipline is seen as a prerequisite for sound economic policy of any country, however, amid such an unprecedented crisis, many governments have gone with the idea of non-observance of fiscal constraints laid down under fiscal responsibility laws. Such a relaxation in stringent budgetary limits would allow them to breach the permissible level of fiscal deficit, hence, opening broader ways for public expenditure.

How different countries are reshaping their own laws
Shortly, after the public health protection measures amid the pandemic, different governments announced their respective bailout plans, aimed at providing a boost to the economy. The European Union suspended the deficit limits for its member nations set out in the stability and growth pact for assisting the market. Through a statement issued by the European Commission, it invoked the general escape clause of the pact, providing full flexibility to the member states – for spending on public health and relief measures. By invoking the escape clause, the EU will be exempting its members from the assessment on compliance with the fiscal rules of the pact. The commission has also sanctioned huge spending for permitting liquidity for support to firms and workers. However, the long and medium term commitments of the members are left untouched under the pact.

Amongst EU members, Germany went with the idea of suspending its fiscal limits established in its constitution, which sets the upper cap of borrowing at 0.35% of economic output for larger borrowing needs. Likewise, the Slovenian and Dutch governments have also relaxed their national fiscal laws for providing such stimulus. While in Latin America; the outbreak of pandemic has opened a debate as to whether they have the required space for breaching the rules or not. Its biggest economy, Brazil, insisted that its budget deficit goal set under Brazilian fiscal responsibility law, 2000, is under review when it injected a $30 billion package into the economy. In the major Asian economies, China has pledged to pump more liquidity into the monetary system, even at the cost of a widened fiscal deficit. The politburo of CPC announced to remove the implicit cap on the deficit at 3 % of the GDP, which means that Article 10 of the budget law of the People's Republic of China will be amended in upcoming weeks. The Act prohibits the government from operating on deficit financing, but now Chinese government will loosen the strings of budgetary constraints for pumping state capital into the market. Nearly all of the countries have stressed that along with monetary policy, the existing fiscal policy framework also requires to be modified to a substantial extent, in order to deliver the required fiscal stimulus. 

Indian framework of fiscal laws
India came up with its fiscal discipline law in 2003, by enacting the Fiscal Responsibility and Budget Management Act, 2003, which is meant to maintain the fiscal balance of the union government by way of prescribing a fiscal deficit target. Though it is the main legislative piece for governing the fiscal policy in India, different states have also enacted their own laws to reduce the debt to GDP ratio. It is important to understand the substantial framework of the Act for getting an idea about its operation in present times.

This Act can be divided into three major parts which set out its guiding principles, measures and way of compliance respectively. Section 3 of the Act directs the central government to adopt a medium term fiscal policy and to lay down its fiscal statement before the parliament. Now it is section 4, which is the most crucial provision in the Act, directing the government to set up an annual fiscal deficit target binding on its budget provisions. The second part of the Act is about regulation and transparency in the reports to be laid before the parliament. It seeks to establish a parliamentary supervision on the economic policy of the government for ensuring adherence to the rules of the Act. Lastly, the third part is related to settlement of the legal issues in the Act which also bars the jurisdiction of civil court in legality of actions taken under this Act. This idea is based on separation of powers so that the judicial intervention in the economic policy can be minimized.

● Possible suggestions from discussions on FRBM Act in light of Corona
When there is a general consensus on the need for huge public expenditure on healthcare and assistance to the economy; it’s equally true that it will widen the fiscal deficit of the government accounts. As economists have suggested that we have entered into a situation of “warlike economy”, the relevance of the FRBM Act is simply an out-of-the-box question. India’s macroeconomic response to the pandemic has already been rated as the weakest among the major economies of the world due to its smaller sized relief package. But at the same time, it can’t be denied straightforwardly that this has been done keeping in mind the long-term macroeconomic stability which gets support by this Act itself.

However, given the flexibility/escape clause in the Act, its tweaked application during such a crisis is entirely permissible. Sec. 4(2) of the Act provides for deviation in the fiscal deficit targets on grounds of national security, act of war, national calamity, collapse of agriculture severely affecting farm output and incomes, or structural reforms in the economy. When the pandemic has already been declared a national calamity under the Disaster management Act, application of the above mentioned clause isn’t a legal anomaly per se. Further, the operation of the Act has been suspended in the past – during the 2008 financial crisis for revival of the economy, so it would be prudent to get away with its provisions for a short time until the economy witnesses a rebound.

Several state governments are also registering objections before the centre due to budgetary limits placed by the Act, which requires their deficit to be under 3% of the GSDP. No doubt, that such an untimely application of its provisions during a crisis also goes against the spirit of fiscal federalism. A study by the RBI shows that though states have managed to keep their deficit targets under the prescribed limits; a preceding slowdown and now, huge expenditure involved in managing the pandemic makes it impossible for them to maintain the balance. Therefore, a temporary exemption should be provided to all of them from provisions of this Act by way of an amendment. This idea also makes sense because a dip in economic activity would lead to a lower tax collection for state expenditure, so the ceiling of fiscal deficit must be raised to a substantial level for allowing them to do so. However, in doing so, it must also be kept in mind that the cap should not be uniform for all states, as a few of them are demanding it to be raised at 4% or 5% of GSDP, but it should be relative according to the existing level of deficit in their accounts. If done so, it would maintain parity in state expenditure.

As it’s widely accepted that unwanted judicial intervention in economic policy impedes growth, courts should also be wary of indulging their time and machinery into checking application of the fiscal policy unless it goes substantially against constitutional principles. Amid this time, economic planning should be strictly left for the executive domain only. One important inference that can be drawn from other economies is the well defined structure of their ‘escape clause’ under fiscal laws for exceptional economic conditions and natural disasters. It makes it quite easier for the government to obtain parliamentary approval due to well specified limits.

Concluding remarks
Even without suspension or amendment into the Act, its prudent application is required at this time, such as monetising the deficit by RBI through the purchase of bonds issued by the government under the Section 5(3) of the Act. It would help the government in raising funds required to combat this challenge. The entry of the RBI into the primary market would certainly bring more relief for the government. This unprecedented crisis requires a completely different approach from the government for revival of the economy. It must be borne in mind that fiscal responsibility is a way to achieve economic stability but when the stability itself is seeing potential threat, arguments about sticking to fiscal discipline makes little sense.

Pratik Kumar is a II Year B.A LL.B (Hons.) student at Dr. Ram Manohar Lohiya National Law University, Lucknow.

 

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