Fifty-one countries have legislated a publicly financed Independent Fiscal Institution (IFI) to provide unbiased analysis of public spending, forecast the economic outcomes thereof and review government performance versus fiscal rules (targets) to improve fiscal and financial stability.
Supreme audit institutions (like the Comptroller and Auditor General in India) do this regularly ex post facto and only from an accounting point of view. In contrast, IFIs work ex-ante, in real-time, to measure and signal to voters the economic competence of governments in achieving their own fiscal targets. This helps political parties in the opposition to demand granular performance whilst business gets insights, for making decisions affected by inflation or high deficits. Can this disruptive mechanism, which relies on access to government documents for independent assessments, technical excellence, and the willingness of the government to stomach evidenced appraisal, work in the Indian context?
Independent fiscal institutions
The first IFI was conceived in the Netherlands in 1945 to popularise macroeconomic modelling for government forecasts and analysis, helmed by Jan Tinbergen, a Dutch economist, who went on to become a Nobel Laureate in 1969.
IFIs are effective only if their independence is respected, and their impartiality is nurtured. In the United States (US), the Congressional Budget Office was created in 1974 (in the aftermath of the 1970s stagflation) to assist congressional committees in examining budget proposals sent by the President for approval. The United Kingdom adopted this practice more recently in 2010, post the “Western Financial Crisis” driven rush for fiscal resilience in 2009.
Expectations were that the Office for Budget Responsibility (OBR) located within the executive could work autonomously. Sadly, within twelve years, on September 2022, the Tory government of Prime Minister Liz Truss and chancellor Kwasi Kwarteng, impatient with the constraints of “Treasury Orthodoxy” (fiscal constraints) and eager to emulate Thatcherite economic unorthodoxy, tabled a “mini budget”—later dubbed “reverse Robinhood” proposal-slashing the top tax rate and scrapping the cap on banker bonuses—the biggest tax cut in 50 years. It also proposed populist subsidies for household energy bills inflated by the Ukraine crisis. It chose to bypass the OBR which previews all budget proposals.
Markets, sensing spending splurge fueled inflation, sold off “gilts”. The interest rate on 10-year treasury bonds soared from 4 to 5 percent. The GBP depreciated to a never before US$1.08 forcing the Bank of England to intervene. It was downhill thereafter, till the PM resigned a month later. The case for IFI compulsory prereview could not have been better made.
Till 2008 only 12 countries had developed similar institutions. Of these, oddly, four were in developing economies—Iran (1991), Uganda (2001), Kenya, and Vietnam (both 2007). The 2008/09 Financial Crisis brought a rush of 20 new institutions – of which 16 were complying with a European Union directive. More followed subsequently. Three notable exceptions are China, Japan, and India. Asia in general has not been warm to the idea except for Vietnam and South Korea.
FRBM review committee 2016
In 2016, the Union government constituted a committee to review the working of the Fiscal Responsibility and Budget Management (FRBM) Act, 2003 versus its broad objectives of fiscal consolidation. The mandate (abbreviated version) of the review committee was to review the efficacy of the fiscal rules established under the Act and to suggest alternatives.
The report submitted in 2017 to the Union government, recommended, as one of the actionable steps, the constitution of a permanent, autonomous IFI (Fiscal Council) of three members, appointed by the government to provide a debt and fiscal sustainability analysis based on fiscal rules (targets for debt and deficits) established under the Act; prepare multi-year fiscal forecasts; produce an annual fiscal strategy report assessing the fiscal performance of the Union government; prepare the annual Macroeconomic Framework Statement; improve the quality of fiscal data; prepare a comprehensive statement of liabilities; respond to requests from the government for policy advice; advise the Union government on the suitability of invoking the escape clause route for fiscal rules and recommend the re-entry path to be followed, post deviations from fiscal rules.
An IFI-style institutional innovation had not been specifically requested by the government nor did it seem urgent to institute one. In 2016-17, the general government (union and state governments) fiscal deficit was at 6.9 percent of GDP, reducing to below the norm of 6 percent in the succeeding two years with the primary deficit at 2.2 percent, reducing to 1.1 percent of GDP. Over the same period, liabilities of the general government rose from 68.8 percent to 70.5 percent of GDP—admittedly, a hefty 10 percentage points out of kilter with the prescribed cap of 60 percent of GDP. However, buoyant growth of 8.3 percent in Gross National Income (constant) in 2016-17, possibly lulled the government into dismissing the trend of decreasing growth—6.9 and 6.6 percent in the following two fiscal years, as a temporary aberration, due to the economic dislocation from the twin blows of demonetization and introduction of the omnibus Goods and Services tax.
India’s respectable macroeconomic indicators
Things are no different now. India’s fiscal resilience is illustrated by macroeconomic indicators no worse than most advanced economies – inflation at 5.7 percent (core inflation at 6 percent) versus double-digit inflation in Latin America, 9.2 percent in the Eurozone and 6.5 percent in the US. A fiscal deficit of 6.4 percent (Union government) trending lower to around 6 percent next fiscal versus 5.5 percent in the United States and 4.2 percent in the Eurozone. India’s swollen stock of general government liabilities at 83 percent of GDP and an adverse current account deficit are both likely to benefit from lower fiscal deficits. The INR depreciated over the last year by 8.2 percent against the US dollar, versus 8.6 percent depreciation in the GBP and 6.1 percent in the Chinese Yuan. Despite global uncertainty, there are no imminent signs of fiscal instability in India.
Equanimity breeds complacence
One adverse outcome of this equanimity is that fiscal reform is likely to be on the back burner beyond trimming the deficit to levels compatible with the 60-percent debt to GDP fiscal rule. India needs more coherence, transparency, and collaboration in the manner fiscal policy and rules are shaped. An autonomous fiscal council is one way of forcing change. The primary characteristic of an IFI is its assured non-partisan nature, independence from government capture and the right to communicate freely with the public. Embedding it within the executive, as the FRBM review committee suggested, would expose it to the kind of capture that autonomous regulatory agencies in India have experienced or for it to be ignored, as in the UK last year.
Embedding structural independence
In the Indian context, independence could be enhanced by embedding the functions of the fiscal council in the Finance Commission (FC) via amendments to Article 280 of the Constitution of India and to the Finance Commission (Miscellaneous Provisions) Act 1951. Since the FC is presently appointed quinquennially for a short period, it does not enjoy the benefits of safeguards on arbitrary dismissal, as afforded to the Comptroller and Auditor General and Chief Election Commissioner. Converting the FC into a permanent body would require a symmetric application of safeguards against arbitrary dismissal.
Parliamentary democracies such as the UK tend to embed their IFI within the executive. But there are exceptions, like Australia, Canada, Italy, Kenya, and South Africa, where the IFI is associated with the legislature—a safeguard against executive overreach. France and Finland, pair the IFI with an existing financial institution, as is proposed here.
Many IFI functions are presently executed by different branches of government. Concentrating these disparate components into one agency can enhance the network effects of specialization and reduce the incremental cost of the enlarged mandate. The existing core functions of the FC relating to inter-governmental transfers would also benefit from a permanent presence, particularly for monitoring outcomes. The FC has brand recognition amongst state governments which account for around 60 percent of public developmental expenditure and are critical for fiscal stability. The skill sets—econometric analysis of fiscal parameters and the analysis of fiscal flows for sustainable and equitable development—are quite similar.
One advantage is that the trust established by the FC, across levels of government, would leverage a quick start for the fiscal council. Real autonomy for the FC with an enlarged mandate can be strengthened by co-opting the leader of the opposition in Parliament in the selection and thereby also, in the disciplining of the FC chair and members.
An IMF 2013 working paper concludes that IFIs add technical rigour to fiscal management thereby, improving fiscal performance. As significant is the transparent ecosystem most well-managed and fiscally prudent economies have, within which an IFI thrives. It is noteworthy that half of G20 members have IFIs. India helms the G20 this year and expects to expand its leadership in other multilateral and plurilateral fora. Best then to choose the route adopted by like-minded fellow travelers rather than travel alone.
This opinion piece was first published in orfonline.org on January 27 2023 https://www.orfonline.org/expert-speak/a-fiscal-council-for-india/