Revised Guarantee Policy and FRBM

  • May 19, 2022
  • Posted by: OptimizeIAS Team
  • Category: DPN Topics
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Revised Guarantee Policy and FRBM

Subject: Economy

Section: Fiscal Policy

Why in the news?

Finance Ministry has come out with a new Government Guarantee Policy, which aims to include all the changes in General Financial Rules and financial policies.

Need:

  • Such a policy is required as the volume of sovereign guarantees undertaken during a financial year is limited to 0.5 per cent of the GDP as per the Fiscal Responsibility and Budget Management Act, 2003.
  • It intends to improve the viability of projects or activities undertaken by Central entities with significant social and economic benefits.
  • It also enables Central PSUs to raise resources at lower interest charges or on more favourable terms.
  • Its objective is to fulfill the requirement in cases where sovereign guarantee is a precondition for concessional loans from bilateral/multilateral agencies to Central PSUs.

Details:

  • Ministries and departments will have to submit the initial proposal on a dedicated portal and then send a physical copy to the budget division, which will process it.
  • Approval or otherwise will be conveyed to ministries/departments through a guarantee portal.
  • Once approved, the ministry/department may enter into a guarantee agreement.
  • The ministry/department will pay an applicable guarantee fee on the day of signing the agreement and thereafter, on April 1 every year.
  • Guarantee fee has been categorised into two based on risk rating:
    • For category ‘A’, the fee will be 0.5-0.6 percent depending upon tenor
    • For category ‘B’, it will be 0.7-0.9 percent.
  • Details such as loan drawn history, repayments, etc. needs to be updated on the portal and a review report sent to the budget division.

Fiscal Responsibility and Budget Management Act, 2003.

The FRBM Act is a law enacted by the Government of India in 2003 to ensure fiscal discipline. It is considered as one of the major legal steps taken in the direction of fiscal consolidation in India.

The main objectives of the act were:

  • to introduce transparent fiscal management systems in the country.
  • to introduce a more equitable and manageable distribution of the country’s debts over the years.
  • to aim for fiscal stability for India in the long run

The FRBM act also provided for certain documents to be tabled in the Parliament of India, along with Budget, annually with regards to the country’s fiscal policy. This included the: 

  1. Medium-term Fiscal Policy Statement,
  2. Fiscal Policy Strategy Statement,
  3. Macro-economic Framework Statement, and
  4. Medium-term Expenditure Framework Statement
  • Revenue Deficit Target – revenue deficit should be completely eliminated by March 31, 2009. The minimum annual reduction target was 0.5% of GDP.
  • Fiscal Deficit Target – fiscal deficit should be reduced to 3% of GDP by March 31, 2009. The minimum annual reduction target was 0.3% of GDP.
  • Contingent Liabilities – The Central Government shall not give incremental guarantees aggregating an amount exceeding 0.5 per cent of GDP in any financial year beginning 2004-05.
  • Additional Liabilities –  Additional liabilities (including external debt at current exchange rate) should be reduced to 9% of the GDP by 2004-05. The minimum annual reduction target in each subsequent year to be 1% of GDP.
  • RBI purchase of government bonds – to cease from 1 April 2006. This indicates the government not to borrow directly from the RBI.

The rules for implementing the Act were notified in July 2004. The rules were amended in 2008, 2015, 2018, and most recently to the setting of a target of 3.1% for March 2023

N.K. Singh Committee

In May 2016, the government set up a committee under NK Singh to review the FRBM Act. The Committee suggested using debt as the primary target for fiscal policy.

The targets set by NK Singh:

  • Debt to GDP ratio: The review committee advocated for a Debt to GDP ratio of 60% to be targeted with a 40% limit for the centre and 20% limit for the states.
  • Revenue Deficit Target – revenue deficit should be reduced to 0.8% of GDP by March 31, 2023. The minimum annual reduction target was 0.5% of GDP.
  • Fiscal Deficit Target – fiscal deficit should be reduced to 2.5% of GDP by March 31, 2023. The minimum annual reduction target was 0.3% of GDP.

Escape Clause:

In 2018, the FRBM Act was further amended. The clause allows the government to relax the fiscal deficit target for up to 50 basis points or 0.5 per cent. Under FRBM, if the escape clause is triggered to allow for a breach of fiscal deficit target, the RBI is then allowed to participate directly in the primary auction of government bonds, thus formalising deficit financing.

Under Section 4(2) of the Act, the Centre can exceed the annual fiscal deficit target citing certain grounds:

  • National security, war
  • National calamity
  • Collapse of agriculture
  • Structural reforms
  • Decline in real output growth of a quarter by at least three percentage points below the average of the previous four quarters.

Fiscal Consolidation at State level:

To ensure that the States too are financially prudent, the 12th Finance Commission’s recommendations in 2004 linked debt relief to States with their enactment of similar laws.

The States have since enacted their own respective Financial Responsibility Legislation, which sets the same 3% of Gross State Domestic Product (GSDP) cap on their annual budget deficits.

economy Revised Guarantee Policy and FRBM