BackIndia’s fiscal architecture needs changes
There is a need for efficient public financial management, greater clarity in fiscal rules and establishment of fiscal institutions to widen accountability
PremiumThe covid-19 crisis has brought new risks to public finance given its extent, the inability of sub-national governments to absorb the fiscal costs, and the asymmetric regional impact of the crisis. These risks well exceed those experienced in the 2008 global financial crisis. The sheer magnitude of fiscal support has highlighted and exposed the weak fiscal in many countries.
A key lesson from history is that accountability and efficiency in public financial management become more critical during crises. Without improving the adaptability and responsiveness of fiscal management, the costs to the economy from misdirected resources and inefficient resource use will compound the effects of the covid crisis.
The challenges currently being faced highlight the need for greater clarity in the three pillars of the fiscal architecture: public financial management processes; the nature of the fiscal rules; and the establishment of fiscal institutions to widen accountability over the fiscal rules. While many countries don’t have the fiscal architecture fully in place, a growing number are quickly putting in place new and innovative coordination mechanisms, involving governance and fiscal tools, to strengthen the pillars. Over the past decade since the global financial crisis, international experience in fiscal rules, public financial management (PFM) processes, and institutional reforms have certainly been building.
PFM systems
Public financial management (PFM) refers to the set of laws, rules, systems and processes used to mobilize revenue, and allocate and account for the use of public funds. It is well-recognized that a strong PFM system is an essential part of the institutional framework for effective public service delivery—both are closely associated with poverty reduction and economic growth. The first step towards better fiscal management is improving the coverage, timeliness, quality and integrity of fiscal reporting.
Toward this end, most advanced and large emerging market countries have, in the past decade, established legal frameworks for public financial management that set out the budget, reporting, accounting, and audit processes and define the roles and responsibilities of key stakeholders. These laws have aimed at aligning fiscal policy to resource allocations and have paved the way for implementing the standards in the fiscal rules in a credible manner. For instance, New Zealand sets a high standard for transparency and the lucidity of its budget documents. Within middle-income countries, South Africa’s budget documentation is highly transparent and accessible, with extensive debt reporting, and clear and concise fiscal risks reports.
Fiscal rules
With respect to strengthening budget institutions and management practices, and their accountability, many advanced countries have set fiscal rules (including at sub-national levels) to retain the confidence and trust of financial markets. While the fiscal rules have evolved over time, into a broader “second-generation fiscal-framework," trying to balance credibility with flexibility, they are now being tested during the pandemic, prompting a raft of reforms, including the introduction of new rules, revamping of escape clauses, enhancement of monitoring and enforcement mechanisms, and reconsideration of procedures and practices to ensure fiscal sustainability.
From international experience, well-designed and well-implemented fiscal rules have helped contain the ‘deficit bias’, strengthen market credibility of the commitment to fiscal sustainability, and allow countercyclical fiscal management. By increasing the predictability of fiscal policy, they have helped lower output volatility and raise sustainable growth.
However, the challenge to achieve these outcomes is at least three-fold: to ensure that they are well-designed, that the public financial management systems and institutions allow them to be well monitored and implemented, and deviations from the fiscal rules allow the return to the rules in a time-bound manner. Unless these challenges can be met, fiscal rules can quickly lose their relevance and credibility. A crucial element is subjecting the process to external scrutiny and parliamentary approval, which will balance flexibility with credibility. One way to overcome this is to grant this mandate to independent fiscal councils.
Fiscal institutions
There has also been a sharp rise of established independent fiscal institutions (fiscal councils) to enhance the credibility of the fiscal rules, help impose hard budget constraints on the public sector, and monitor the long-term sustainability of government fiscal stances. Fiscal rules and fiscal councils have developed as complements. Good councils will learn how to better interpret the fiscal rules and to suggest improvements. Well-designed rules will make the task of councils easier to perform and less controversial than poorly designed or weak rules. Thus, effective rules and functioning councils are expected to reinforce each other.
Over the past decade, there has been a global trend to set up independent public bodies that provide non-partisan oversight and analysis of fiscal policy and performance to inform public decision-making. Independent fiscal institutions are now a common component of fiscal frameworks in most advanced economies, and the overall number of countries with such fiscal councils has more than tripled over the past decade. While these fiscal institutions take many forms, their tasks typically include preparing or assessing macroeconomic or fiscal forecasts, monitoring compliance with fiscal rules, budgetary analysis, long-term fiscal sustainability analysis and, for some, policy costing. There are several examples of fiscal councils tasked with a role in national and sub-national fiscal coordination as well. Empirical evidence suggests that fiscal councils can improve forecast accuracy and foster compliance with fiscal rules.
A variety of institutional models exist for the manner and location in which fiscal councils are set up and reside. Effective fiscal councils should have (a) legal and operational independence, (b) strong media presence, and (c) the chair and board members with non-partisan affiliations. Key safeguards for operational independence include secured funding sources, access to information on a timely basis, and ability to manage its own staff. Effective fiscal councils establish contact with the media in line with the budget cycle and at the time their reports are published.
The fiscal legacy of the covid crisis has put a premium on strengthening the institutional anchor for sustainable public finances. As the crisis will continue to cast a long shadow over the public finances of many countries, the need to restore fiscal credibility encourages further reforms of fiscal frameworks. In many countries, efforts are being made to address pre-existing weaknesses and bottlenecks in public financial management systems and set up improved reporting mechanisms to ensure financial transparency and accountability—that would help the reallocation of funds to the front lines of the covid crisis. It is crucial to ensure the full transparency, good governance, and costing of all fiscal measures, especially given their size, exceptional nature, and speed of deployment.
It is India’s moment now to benchmark its fiscal architecture to its peers, learn from the experiences of other federal countries, and adopt some of the best practices. We will discuss these steps in our forthcoming article.
Anoop Singh is a Distinguished Fellow at the Centre for Social and Economic Progress, New Delhi and was a member of the Fifteenth Finance Commission. Kandarp Patel is a civil servant and was a director in the Fifteenth Finance Commission. Views expressed are personal.
This is the first of a two-part special series on India’s fiscal architecture.
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