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Why in News: The Centre has agreed to the demand from states to allow them to borrow more funds to meet spending needs, amid a fall in revenue collection but made a large part of it contingent upon reforms.

• Since the start of the lockdown in March to contain the spread of the disease, states have been clamoring for a relaxation in the amount of money they can borrow.
• This limit is set as per the Fiscal Responsibility and Budget Management Act at 3% of the gross state domestic product.
• Since the Union government has released little money and in fact even held back tax revenue due to the states, this borrowing would help states raise funds in order to fight the pandemic and tide over the severely reduced tax revenue as a result of lockdown.

• The Fiscal Responsibility and Budget Management Act (FRBM Act), 2003, establish financial discipline to reduce fiscal deficit.
• The FRBM Bill was introduced by the then finance minister, Yashwant Sinha, in 2000.
• It was later approved by the Union Cabinet in 2003, became effective from July 5, 2004.
• The FRBM Act was enacted to introduce more equitable distribution of India’s debt over the years.

Objectives of the FRBM Act:
Aim: To introduce transparency in India’s fiscal management systems.
Long term objective: To achieve fiscal stability and to give the Reserve Bank of India (RBI) flexibility to deal with inflation in India.
• In other words, the act aims that the current generation of the country’s administrators must ensure that their management of the country’s finances does not leave future generations saddled with the burden of having to service unsustainably high levels of inherited debt that would in turn affect their ability to provide a stable economic environment for contemporary society.

Key features of the FRBM Act:
-To achieve its aim, the Act envisages the setting of limits on the Central government’s debt and deficits as well as mandating greater transparency in fiscal operations of the Central government and the conduct of fiscal policy in a medium-term framework.

-The FRBM Act made it mandatory for the government to place the following along with the Union Budget documents in Parliament annually:
1.Medium Term Fiscal Policy Statement
2.Macroeconomic Framework Statement
3.Fiscal Policy Statement

-The FRBM Act proposed that revenue deficit, fiscal deficit, tax revenue and the total outstanding liabilities be projected as a Strategy percentage of gross domestic product (GDP) in the medium-term fiscal policy statement.

-It requires the government to limit the fiscal deficit to 3% of the GDP by 31 March 2021 and the debt of the central government to 40% of the GDP by 2024-25, among others.

FRBM Act in States:
• 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.

FRBM Act exemptions:
• The law does contain what is commonly referred to as an ‘escape clause’.
• However, on grounds of national security, calamity, etc, the set targets of fiscal deficits and revenue could be exceeded.
• Section 4(2) of the Act, the Centre can exceed the annual fiscal deficit target citing grounds that include national security, war, national calamity, collapse of agriculture, structural reforms and decline in real output growth of a quarter by at least three percentage points below the average of the previous four quarters.

News Summary:
• The Union government did accede to the states demand of extra borrowings but with significant conditions.
• States can now borrow up to 5% but only if they agree the centers conditions.
• Of the extra 2%, only 0.5% is truly unconditional. However, after that states will only be allowed four increments of 0.25% if they meet specific conditions laid down by Centre.
• The final 0.5% will be awarded to states if they tick off three of four conditions set by the government.
• In other words, the states can borrow up to 3.5% of GSDP without undertaking any reforms, but the remaining headroom will only be available if they move ahead with steps required to implement three of the four reforms.

The four policy conditions are:
• Implement the One Nation, One Ration Card scheme,
• Ensure reforms so that power distribution companies can clear their dues in time,
• undertake reforms of urban local bodies and
• Ensure that there is ease of doing business at the Grass root level.
• This is expected to help them raise an additional Rs 4.3 lakh crore this year.

States protest linking of additional borrowing limit to four reforms:
• Some states have protested the Centre’s move to link the increase in their borrowing limit to conditions such as reforms.
• Several states are expected to protest the move and are likely to convene a meeting to discuss the issue and draw up a strategy.

Arguments given by the states against the recent move:
• It will set a new precedence of what he called “authoritarian intervention” of the Centre on how states can borrow and spend the funds.
• This is undermining the autonomy of elected governments of states by the Centre to make decisions on allocation of borrowings and called it an anti-federalist move.
• In effect, this seeks to weaken the constitutional scheme of separate policy areas for the Centre and states.

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