Fiscal Responsibility and Budget Management Act in India: A Review and Recommendations for Reform

Abstract

The paper assesses India’s experience with fiscal consolidation and performance under the Fiscal Responsibility and Budget Management (FRBM) Act. While the introduction of FRBM rules helped consolidate the finances of both the central and state governments, key challenges under the FRBM Act remain such as (i) a weak linkage between budget policy setting and operational framework, (ii) insufficient coverage or assessment of fiscal risks, and (iii) inadequate course correction under the transparency and accountability framework when fiscal objectives went “off-track.” The paper reviews the international experience and global best practices on fiscal rules, types of rules, introduction of fiscal councils and compares India’s FRBM framework against properties of fiscal frameworks, including fiscal balance, capital spending, optimal debt levels, cyclical considerations, and underlying budget processing and implementation. India’s fiscal rules follow mainly a traditional balanced budget rule with no debt ceiling law while emerging best practices have moved toward either a structural budget balance rule or an expenditure rule. As a consequence, the fiscal framework in India is less flexible to manage the dual goals of fiscal stabilization and debt sustainability. Limited coverage, vague escape clauses, and lack of independent fiscal institutions to monitor compliance with fiscal rules have also led to inefficiencies in implementation. The paper analyzes various reform options based on quantitative fiscal rule simulations, including (i) fiscal prudence with countercyclical stabilization, (ii) anchoring fiscal rules in a debt target vs. a fiscal deficit target, (iii) implications of different aggregate debt targets, and (iv) harmonizing fiscal rules with adequate public investment to stimulate private investment. Quantitative fiscal rule simulations based on a simultaneous equations model show that fiscal deficit, primary deficit, and public debt ratio all gradually decline as a result of a prudent increase in capital expenditure through the interactions of the model. This points to the scope for India to reorient public expenditures toward growth-enhancing investment while maintaining overall fiscal objectives. Finally, the paper presents recommendations on adopting appropriate fiscal rules and targets with clearly defined escape clauses, and strengthening the enforcement of fiscal rules. These include measures such as (i) the establishment of independent fiscal councils; (ii) full-fledged fiscal stability reporting, addressing the coverage of off-budget items like contingent liabilities; (iii) improving linkages between fiscal policy and budget processes; (iv) sharing of responsibilities and coordination within tiers of government for stabilization and sustainability; and (v) introducing state credit ratings for measuring fiscal performance.