Budget 2021: 15th Finance Commission Recommends To Target 4% Fiscal Deficit By FY26
The 15th finance commission, led by NK Singh, presenting the report to President Ram Nath Kovind. (Source: Rashtrapati Bhavan/ Twitter)

Budget 2021: 15th Finance Commission Recommends To Target 4% Fiscal Deficit By FY26

The Fifteenth Finance Commission recommended that India reduce its headline fiscal deficit to 4% in the next five fiscals, allowing a reset in consolidation path as nation needs to spend more to support the economy during the pandemic.

“We have assessed that, given the compulsions on the revenue of the Union Government, including of lending support to the budgets of sub-national governments, they may have to follow an elevated path of fiscal deficit with a terminal year (2025-26) of 4% of the GDP,” the commission, headed led by NK Singh, said in its report which was tabled in the Parliament along with the Budged 2021.

While calling for fiscal prudence from the central and state governments, the commission cited prevailing uncertainty to say that there is need to restructure the Fiscal Responsibility and Budget Management Act (FRBM Act), 2003. The FRBM Act, amid other things, mandates the central government to fix a deficit target and the timeline to achieve it.

In view of the uncertainty that prevails at the stage that we have done our analysis, as well as the contemporary realities and challenges, we recognise that the FRBM Act needs a major restructuring and recommend that the time-table for defining and achieving debt sustainability may be examined by a high-powered inter-governmental group involving the union and state governments.
15th Finance Commission’s Report For 2021-26

The commission said the group can craft new FRBM framework and oversee its implementation.

Also read: Budget 2021: India Pegs FY22 Fiscal Deficit At 6.8%

However, Finance Minister Nirmala Sitharaman, in her budget speech, said the government is committed to bringing the fiscal deficit to below 4.5% of the GDP by 2025-26. The budget gap is expected to widen to 9.5% in the ongoing fiscal year.

India was supposed to bring down its fiscal deficit to 3% of the GDP by FY21 under the FRBM Act. But an economic slowdown, worsened by the Covid-19 pandemic, sent government finances into disarray.

Fiscal Consolidation For States

The commission has recommended states to bring down their combined fiscal deficit to 2.8% of the gross state domestic product by FY26.

It also suggested capping net borrowing for states at 4% of the GSDP in FY22, 3.5% in FY23 and at 3% till FY26. States, however, may get an extra borrowing space to meet their budgetary requirements, subject to certain conditions. They can increase their annual borrowing up by 0.5 percentage points between FY22 and FY25 if certain performance criteria of the power sector are met.

This limit does not include any additional borrowing for states to compensate for a shortfall in the goods and services tax revenue.

States can also consider setting up independent public debt management cells to chart their borrowing programmes efficiently.

Formula To Share Taxes With States

The key role of the Finance Commission is to recommend the tax devolution formula or the share of central taxes that all states are entitled to. The panel has recommended keeping that largely unchanged.

It suggested that 41% of the net proceeds of union taxes be devolved to states in FY21. This is nearly the same as the commission’s report for 2020-21. The Fourteenth Finance Commission had increased the devolution to states by 10 percentage points to 42%.

The one percentage point adjustment, the commission’s report said, was done on account of the erstwhile state of Jammu & Kashmir being split into two new union territories—Jammu & Kashmir and Ladakh.

The 15th Finance Commission was asked to include the 2011 census to suggest devolution of taxes to states—an issue that later became contentious. It was also asked to examine if a separate mechanism for funding defence and internal security is possible.

The commission said the 2011 census data better represents the present need of states and fairly rewards those who have done better on the demographic front.

New Defence Fund

The 15th Finance Commission’s report allowed the government to set up a dedicated fund for defence and internal security. The commission said it “re-calibrated the relative shares of union and states in gross revenue receipts” by reducing the grants component by 1%. This will allow the centre to set aside resources for the fund.

It's not clear yet if the commission has adjusted this 1% in states' 41% share in taxes.

The dedicated non-lapsable fund—Modernisation Fund for Defence and Internal Security—will be constituted to bridge the gap between projected budgetary requirements and budget allocation for defence, the report said. The total indicative size of the fund has been proposed at Rs 2.38 lakh crore for the 2021-26 period.

The proceeds from the fund will be used for:

  • Capital investment for modernisation of defence services.
  • Capital investment for central armed police forces and modernisation of state police forces.
  • Small component as welfare fund for soldiers and paramilitary personnel.

The fund will receive incremental funding from the central government, divestment proceeds of public-sector defence firms and proceeds from monetisation of surplus defence land. The Ministry of Defence will have exclusive rights over the use of the funds' money. The government can also operate the fund through a high-powered committee, the report said.

Other Key Recommendations

  • The finance commission suggested that health spending by states be increased to 8% of their budget by 2022.
  • Total size of grants to local governments should be Rs 4.36 lakh crore for the period 2021-26. Of these, Rs 8,000 crore should be for incubation of new cities.
  • Annual grants worth Rs 1,200 crore be awarded between FY23 and FY26 for incentivising states to enhance educational outcomes.
  • Disaster mitigation funds should be set up at both national and state levels, in line with provisions of the Disaster Management Act.

Follow real-time analysis from BQ’s top editors Menaka Doshi, Ira Dugal, Sajeet Manghat and Niraj Shah here.

BQ Install

Bloomberg Quint

Add BloombergQuint App to Home screen.