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The FRBM escape clause: RBI may have to finance government’s deficit if the clause is invoked

Updated : January 30, 2020 06:14 AM IST

The government has the option under the Fiscal Responsibility and Budget Management (FRBM) Act to increase its fiscal deficit by 0.5 percent. This can be done under extreme circumstances such as war, famine or deep structural reform leading to a fall in taxes. What is less widely known is that the government can also tell the Reserve Bank of India (RBI) to buy bonds directly from it and not from the market like it now does.

The FRBM Act requires the government to keep bringing down its fiscal deficit by 30 basis points each year till it reaches a target of 3 percent, of course now there are discussions that instead of a 3 percent of GDP fiscal deficit end target the government should target a debt to GDP, but that is another discussion.

The point is this year the government was supposed to reach 3.3 percent, but it is very clear that it is not going to be able to achieve that - one, it has fallen short of taxes by 2.1 lakh crore or thereabouts, the year has not ended but it is very clear that at least it will fall 2 lakh crore short . Even non-tax revenues will fall short because the Bharat Petroleum Corporation (BPCL) sale has been postponed. So there is a question in everyone’s mind will the government invoke that escape clause which the FRBM act has.

That clause allows the government to take a 0.50 percentage point of GDP liberty. Government can use that route in this present case by claiming that goods and service tax (GST) and the personal tax cut are deep structural reforms. The point is will they invoke that clause, the question arises more deeply because what we now realise is not only if they invoke the clause can they increase the deficit, they can also tell RBI to directly buy bonds from themselves.

Under the FRBM Act, the RBI cannot buy bonds directly from the Government of India, this used to be the situation pre 1991. Now the point is will the government invoke the clause and therefore will RBI be forced to buy directly.
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