Tough times call for difficult measures to ensure a better future. As India grapples with the fallout of the pandemic and geopolitical turmoil on its finances, the country needs to create an independent fiscal council that will bolster its budgetary performance and improve economic forecasting.
While the large spike in budget deficits since the pandemic hit are an aberration, the government’s fiscal marksmanship has often been off the mark.
Fiscal targets have seldom been met and estimations of nominal growth and revenue have typically been over-optimistic. In recent years, however, these numbers have been underestimated.
The perfect storm of global monetary tightening, higher inflation and supply-side disruptions means that the sovereign will need to keep spending more for a while to come. As such, there is a pressing need for an external and independent scrutiny of the government’s economic forecasts and its budget projections.
About 50 countries have fiscal councils, which act as budgetary watchdogs, raising the reputational and electoral costs of undesirable policies and broken commitments by governments. These councils assess the sovereign’s budget plans and performance, evaluate macroeconomic and budgetary forecasts, and monitor the implementation of fiscal rules, according to the International Monetary Fund.
In India, successive Finance Commissions have recommended the formation of a fiscal council but governments have rejected the proposals.
The establishment of a fiscal council with powers to access records from the Union and state governments was one of the key recommendations of the 15th Finance Commission. The commission said there were institutional gaps in the production, collation, coordination and publication of fiscal data, as well as an independent review of fiscal projections and the medium-term budgetary framework across all levels of government.
Shape of the new body
A fiscal council must be independent, non-partisan and underpinned by a clear legal framework that gives it a statutory footing, according to the 15th Finance Commission’s report.
Provisions must also be made with respect to its leadership, resources, mandate, functions, publications, and access to information.
On where the fiscal council can be housed, there are a few options.
While the US Congressional Budget Office has legal separation from the executive and lawmakers, the UK’s Office for Budget Responsibility is responsible to both the executive and the parliament. About 33 percent of fiscal councils are independent bodies based in parliaments.
It is uncommon for fiscal councils to be housed within the executive, in national audit offices, or central banks, according to the 15th Finance Commission.
What the fiscal council should do
Provide multi-year macroeconomic and fiscal forecasts: In India, the government and central bank issue official economic forecasts. While the finance ministry’s economic survey projects real growth for the next financial year, the budget assumes a nominal GDP growth on the basis of which it makes projections for its revenue, expenditure, and fiscal deficit targets for the year.
The central bank also estimates growth and inflation, typically over a nine-to-12-month horizon. Another non-partisan assessment will provide robustness to policymaking in India.
Evaluate fiscal performance: Right now, the Central government gets a free pass when it misses budget gap targets. So do the states. A fiscal council’s independent evaluation of budget outcomes would keep a check on fiscal profligacy. Several fiscal councils across the world also provide recommendations on fiscal policies to inform the public debate.
Assess long-term fiscal sustainability: While the Fiscal Responsibility and Budget Management Review Committee recommended that both the Central and states governments must bring down their debt-to-GDP ratios, these targets have been roiled by the record fiscal expansion during the pandemic.
Governments also often disregarded concerns raised by rating companies, especially when such commentary is not favourable. An independent assessment by a fiscal council could go a long way in keeping a check on government spending, especially in the good times.
Assess fiscal policy statements and costing of new measures: A fiscal council will bring in external assessment of whether fiscal targets are being met or missed and warn about the impact of new schemes that could result in the ballooning of expenditure.
Why now?
According to Lekha Chakraborty, professor at the National Institute of Public Finance and Policy, an autonomous research institute under the ministry of finance, fiscal transparency and accountability are needed for the market to have confidence in a high public debt regime.
“Constituting a Fiscal Council in India is, therefore, crucial at this juncture to analyse the fiscal risks and to formulate post-pandemic fiscal strategies to ensure fiscal credibility in times of geopolitical uncertainties,” Chakraborty wrote in an article.
The Covid-19 pandemic and the current geopolitical as well as economic uncertainties present a good opportunity for the government to do some much needed housekeeping. India’s finance ministry has already used the pandemic-era budgets to clear liabilities like dues of the Food Corporation of India and started declaring public sector borrowings as part of the budget documents.
Still, it faces an uphill task as the debt-to-GDP ratio is estimated to remain elevated despite solid medium-term growth prospects.
Also, global monetary tightening means higher interest costs. Note that the government pays about one-fourth of its revenue as interest.
All this means that the overall fiscal metrics may be strained for several years, keeping borrowing costs in the economy higher for longer.
A fiscal council may just be the way out.
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