The Fiscal Responsibility Act

Section 2 is not ordinary at all, because the whole of section 4 is written in words this section defines. A target expressed as a percentage of something means nothing until the something is defined, and the amendments of 2018 are almost entirely amendments to this section.

"Fiscal deficit" means "the excess of total disbursements, from the Consolidated Fund of India, excluding repayment of debt, over total receipts into the Fund (excluding the debt receipts), during a financial year." Both exclusions matter: repaying a loan is not spending, and raising one is not income, so the definition measures the gap the Government must borrow to fill.

"Central Government debt" at any date means the total outstanding liabilities on the security of the Consolidated Fund of India, including external debt valued at current exchange rates; the total outstanding liabilities in the public account of India; and "such financial liabilities of any body corporate or other entity owned or controlled by the Central Government, which the Government is to repay or service from the annual financial statement", reduced by the cash balance available at the end of that date.

Read that third limb slowly, because it is the anti-avoidance clause of the whole Act. Without it a Government could keep its own debt inside a wholly owned corporation and report a falling figure while the liability grew; the definition reaches a liability the Government will in fact have to service out of the annual financial statement, whoever formally owes it. Chapter 1450's audit of Government companies is the machinery by which such a liability becomes visible.

"General Government debt" means "the sum total of the debt of the Central Government and the State Governments, excluding inter-Governmental liabilities", which is why section 4(1)(b)(i) can set a target for the country and not merely for the Union.

"Fiscal indicators" means "the measures such as numerical ceilings and proportions to gross domestic product, as may be prescribed, for evaluation of the fiscal position of the Central Government", so the indicators themselves are left to rules, which is chapter 1500's point about section 8.

"Gross domestic product", "real gross domestic product" and "real output growth" are defined by reference to what the Central Statistics Office publishes, and "prescribed" means prescribed by rules under the Act. "Reserve Bank" means the Bank constituted under section 3(1) of the Reserve Bank of India Act 1934, which is the bank section 5 forbids the Government to borrow from.

The examinable point about section 2 in one line. Every number in section 4 is a ratio, and section 2 defines both halves of every ratio; a target is only as honest as its definitions, and the 2018 amendments were largely a tightening of these.

Section 3: the four statements

3(1). The Central Government shall lay in each financial year before both Houses of Parliament the following statements of fiscal policy along with the annual financial statement and demands for grants, except the Medium-term Expenditure Framework Statement:

(a) the Medium-term Fiscal Policy Statement; (b) the Fiscal Policy Strategy Statement; (c) the Macro-economic Framework Statement; (d) the Medium-term Expenditure Framework Statement.

3(1A) and (1B), inserted by amendment: the statements in clauses (a) to (c) shall be followed up with the Medium-term Expenditure Framework Statement with detailed analysis of underlying assumptions, which shall be laid immediately following the session in which the first three were laid.

3(2). The Medium-term Fiscal Policy Statement shall set forth a three-year rolling target for prescribed fiscal indicators with specification of underlying assumptions.

Read section 3(2) for the two features that make the Act work.

A three-year rolling target. Not a target for the coming year alone. A Government must state where it intends the deficit to be in three years, and must restate it every year, so that a departure from last year's stated path is visible in this year's statement.

With specification of underlying assumptions. The assumptions must be stated, which is what allows a reader to see that a target was met by assuming an implausible rate of growth. A target without its assumptions is unfalsifiable; the Act requires both.

Section 4: the fiscal management principles

4(1). The Central Government shall:

(a) take appropriate measures to limit the fiscal deficit up to three per cent of gross domestic product by the 31st March 2021;

(b) endeavour to ensure that (i) the general Government debt does not exceed sixty per cent and (ii) the Central Government debt does not exceed forty per cent of gross domestic product by the end of financial year 2024-2025;

(c) not give additional guarantees with respect to any loan on the security of the Consolidated Fund of India in excess of one-half per cent of gross domestic product in any financial year;

(d) endeavour to ensure that the targets in (a) and (b) are not exceeded after the stipulated target dates.

Notice the verbs, because they decide the legal character of the whole Act. Clause (a) says "take appropriate measures to limit". Clauses (b) and (d) say "endeavour to ensure". Only clause (c), the guarantees cap, is an unqualified "shall not".

So the deficit and debt targets are duties of ENDEAVOUR, and the guarantee cap is a prohibition. A candidate who notices that has found the honest measure of the Act's bite.

The escape clause, in the proviso to section 4(2). Exceeding the annual fiscal deficit target may be allowed on the ground or grounds of national security, act of war, national calamity, collapse of agriculture severely affecting farm output and incomes, structural reforms in the economy with unanticipated fiscal implications, or decline in real output growth of a quarter by at least three per cent points below its average of the previous four quarters.

4(3): the cap on the escape. Any deviation from the fiscal deficit target under sub-section (2) shall not exceed one-half per cent of the gross domestic product in a year.

4(4): the symmetry. Where real output growth of a quarter increases by at least three per cent points above its average of the previous four quarters, the Government shall reduce the fiscal deficit by at least one-quarter per cent of gross domestic product in a year.

Sub-sections (3) and (4) are the two features that make the escape clause a rule rather than a hole. The deviation is capped, and the good years carry a duty to consolidate. An escape clause with a numerical limit and a matching obligation on the upside is a serious provision, and an answer should say so before criticising the Act.

Section 5: borrowing from the Reserve Bank

5(1). The Central Government shall not borrow from the Reserve Bank.

5(2). It may borrow by way of advances to meet temporary excess of cash disbursement over cash receipts during a financial year, under agreements with the Bank; and such advances are repayable as the Reserve Bank of India Act provides.

5(3), inserted by amendment: notwithstanding sub-section (1), the Reserve Bank may subscribe to the primary issues of Central Government Securities on the grounds specified in the proviso to section 4(2), that is the escape-clause grounds.

5(4). The Reserve Bank may buy and sell Central Government securities in the secondary market, or convert securities it holds.

Why section 5(1) is the most important prohibition in the Act. A Government that can borrow directly from the central bank can finance a deficit by creating money, and a deficit financed that way appears in nobody's vote and is paid for by inflation. Section 5(1) closes the door, and the exceptions are confined to temporary cash mismatches, to the escape-clause grounds, and to secondary market operations which are the Bank's own monetary policy and not lending to the Government.

Section 6: transparency

6(1). The Central Government shall take suitable measures to ensure greater transparency in its fiscal operations in public interest and minimise as far as practicable, secrecy in the preparation of the annual financial statement and demands for grants.

6(2). In particular, it shall, at the time of presentation of the annual financial statement and demands for grants, make such disclosures and in such form as may be prescribed.

Note the object of section 6(1), which is unusual and worth quoting. It requires the Government to minimise secrecy in the preparation of the Budget. Budget secrecy is a strong convention; the Act qualifies it by statute, "as far as practicable", in the interest of transparency.

Section 7: measures to enforce compliance

7(1). The Minister-in-charge of the Ministry of Finance shall review, on a half-yearly basis, the trends in receipts and expenditure in relation to the budget and place before both Houses of Parliament the outcome of such reviews.

7(1A), inserted by amendment: the Central Government shall prepare a monthly statement of its accounts.

7(2). Whenever there is either a shortfall in revenue or an excess of expenditure over the prescribed levels during any period in a financial year, the Central Government shall take appropriate measures for increasing revenue or for reducing the expenditure, including curtailing the sums authorised to be paid and applied from the Consolidated Fund under any Appropriation Act.

Proviso: nothing in the sub-section applies to expenditure charged on the Consolidated Fund under article 112(3), or to expenditure required to be incurred under any agreement or contract, or to such other expenditure which cannot be postponed or curtailed.

Section 7(2) is remarkable and students walk past it. It authorises the Government to curtail sums Parliament has appropriated. Chapter 1330 established that article 114(3) forbids withdrawal except under an appropriation; section 7(2) does not authorise spending beyond the appropriation but spending LESS than it, which the Constitution nowhere forbids.

And the proviso is the safeguard on that power. Charged expenditure under article 112(3) cannot be curtailed, which protects everything chapter 1320 identified as beyond the vote, including the Comptroller and Auditor-General's own office; nor may expenditure required under a contract; nor what cannot be postponed or curtailed.

Section 8: rules

The Central Government may by notification in the Official Gazette make rules for carrying out the Act, in particular for the annual targets under section 4(2), the fiscal indicators under section 3(2), the expenditure indicators with specifications of underlying assumptions and risk, and the forms of the four statements.

And chapter 1500 reads section 9, which requires those rules to be laid before each House in the standard form chapter 1230 worked.

A worked example

A Budget is presented in a year of poor growth.

What must be laid with it? Section 3(1): the Medium-term Fiscal Policy Statement, the Fiscal Policy Strategy Statement and the Macro-economic Framework Statement, with the Medium-term Expenditure Framework Statement to follow immediately after that session.

What must the first of them contain? Section 3(2): a three-year rolling target for prescribed fiscal indicators with specification of underlying assumptions.

The Government proposes a fiscal deficit above the target. It may do so only on a ground in the proviso to section 4(2), such as a decline in real output growth of a quarter by at least three per cent points below its average of the previous four quarters; and by section 4(3) the deviation shall not exceed one-half per cent of gross domestic product in a year.

Growth then recovers strongly. Section 4(4): where growth in a quarter exceeds its four-quarter average by at least three per cent points, the Government shall reduce the fiscal deficit by at least one-quarter per cent of gross domestic product in a year.

The Government proposes to fund the gap by borrowing from the Reserve Bank. Section 5(1): it shall not. It may take advances for a temporary cash mismatch under section 5(2), and the Bank may subscribe to primary issues under section 5(3) only on the escape-clause grounds.

Mid-year, revenue falls short. Section 7(1): the Finance Minister reviews half-yearly and places the outcome before both Houses. Section 7(2): the Government shall take appropriate measures, including curtailing sums authorised by an Appropriation Act.

It proposes to curtail the Comptroller and Auditor-General's establishment. The proviso to section 7(2) forbids it: that expenditure is charged under article 112(3) and article 148(6).

And it proposes to curtail payments due under a signed contract. Also excluded by the proviso.

What beginners get wrong

That the Act forbids a deficit. It requires targets to be stated and laid, and clause (a) of section 4(1) speaks of taking appropriate measures to limit the deficit.

That the targets are absolute duties. The debt targets and the post-date duty are to endeavour to ensure; only the guarantee cap in clause (c) is an unqualified prohibition.

That the escape clause has no limits. The grounds are enumerated, the deviation is capped at one-half per cent of gross domestic product, and section 4(4) imposes a duty to consolidate in good quarters.

That the Government may borrow from the Reserve Bank in the ordinary course. Section 5(1) forbids it; the exceptions are temporary advances, the escape-clause grounds and secondary market operations.

That section 7(2) lets the Government overspend. It lets it spend less than appropriated, and the proviso protects charged expenditure, contractual obligations and what cannot be curtailed.

Quick revision

s.3(1): lay each financial year before both Houses, with the annual financial statement and demands for grants: the Medium-term Fiscal Policy Statement, the Fiscal Policy Strategy Statement, the Macro-economic Framework Statement, and (following the session) the Medium-term Expenditure Framework Statement. s.3(2): a three-year rolling target for prescribed fiscal indicators with specification of underlying assumptions.

s.4(1): (a) limit the fiscal deficit up to three per cent of GDP by 31 March 2021; (b) endeavour that general Government debt not exceed sixty per cent and Central Government debt forty per cent of GDP by end 2024-2025; (c) not give additional guarantees on the security of the Fund exceeding one-half per cent of GDP in any financial year; (d) endeavour that the targets are not exceeded after the stipulated dates. Verbs: "limit", "endeavour", and only (c) an unqualified "shall not".

Escape clause, proviso to s.4(2): national security, act of war, national calamity, collapse of agriculture severely affecting farm output and incomes, structural reforms with unanticipated fiscal implications, or a fall in quarterly real output growth of at least three percentage points below the previous four quarters' average. s.4(3): deviation not to exceed one-half per cent of GDP in a year. s.4(4): on a rise of at least three percentage points, reduce the deficit by at least one-quarter per cent of GDP.

s.5(1): shall not borrow from the Reserve Bank; exceptions: temporary advances (5(2)), primary subscription on escape-clause grounds (5(3)), secondary market operations (5(4)).

s.6: greater transparency and minimise as far as practicable secrecy in the preparation of the statement and demands; prescribed disclosures at presentation.

s.7: half-yearly review by the Finance Minister, placed before both Houses; a monthly statement of accounts; and on a shortfall or excess, appropriate measures including curtailing sums authorised by an Appropriation Act, except charged expenditure under art 112(3), contractual obligations, and what cannot be postponed or curtailed.

Test yourself

1. What does the Act require to be laid before Parliament? Section 3(1) requires the Central Government to lay in each financial year before both Houses, along with the annual financial statement and the demands for grants, the Medium-term Fiscal Policy Statement, the Fiscal Policy Strategy Statement and the Macro-economic Framework Statement; and, by sub-sections (1A) and (1B), to follow those up with the Medium-term Expenditure Framework Statement, containing a detailed analysis of underlying assumptions, laid immediately following the session in which the first three were laid. By section 3(2) the Medium-term Fiscal Policy Statement must set forth a three-year rolling target for prescribed fiscal indicators with specification of underlying assumptions, which are the two features that make the discipline effective: a rolling target makes a departure from last year's stated path visible in this year's statement, and the requirement to specify assumptions prevents a target from being met on paper by assuming an implausible rate of growth.

2. What are the fiscal management principles in section 4, and how strong are they? The Central Government shall take appropriate measures to limit the fiscal deficit up to three per cent of gross domestic product by 31 March 2021; shall endeavour to ensure that general Government debt does not exceed sixty per cent and Central Government debt forty per cent of gross domestic product by the end of the financial year 2024-2025; shall not give additional guarantees with respect to any loan on the security of the Consolidated Fund in excess of one-half per cent of gross domestic product in any financial year; and shall endeavour to ensure that the targets are not exceeded after the stipulated dates. Their strength varies with the verb: the deficit obligation is to take appropriate measures to limit, the debt and post-date obligations are to endeavour to ensure, and only the cap on additional guarantees is an unqualified prohibition. That is the honest measure of the Act's bite.

3. Is the escape clause a loophole? It is a serious provision rather than a hole, for three reasons. The grounds are enumerated and are not general: national security, an act of war, a national calamity, a collapse of agriculture severely affecting farm output and incomes, structural reforms in the economy with unanticipated fiscal implications, and a decline in real output growth of a quarter by at least three percentage points below its average of the previous four quarters. The permitted deviation is capped by section 4(3) at one-half per cent of gross domestic product in a year. And section 4(4) imposes the corresponding duty on the upside, requiring the Government, where real output growth of a quarter exceeds its four-quarter average by at least three percentage points, to reduce the fiscal deficit by at least one-quarter per cent of gross domestic product in a year. An escape clause with enumerated grounds, a numerical limit and a matching consolidation duty is a rule and not an exception without content.

4. Why does section 5(1) matter, and what does section 7(2) permit? Section 5(1) provides that the Central Government shall not borrow from the Reserve Bank, and it matters because a Government able to borrow directly from the central bank can finance a deficit by the creation of money, which appears in no vote of the House and is paid for by inflation; the exceptions are confined to advances to meet a temporary excess of cash disbursement over cash receipts, to the Bank's subscription to primary issues on the escape-clause grounds, and to secondary market operations which are the Bank's own monetary policy rather than lending to the Government. Section 7(2) requires the Government, whenever there is a shortfall in revenue or an excess of expenditure over the prescribed levels, to take appropriate measures for increasing revenue or reducing expenditure, including curtailing the sums authorised to be paid and applied from the Consolidated Fund under an Appropriation Act; that is a power to spend less than Parliament appropriated, which the Constitution nowhere forbids, and the proviso protects expenditure charged under article 112(3), expenditure required under any agreement or contract, and such other expenditure as cannot be postponed or curtailed.