The Fiscal Responsibility & Budget management Act (FRBM) hurriedly passed by the Vajpayee government in 2003 has severe consequences detrimental to the Indian economy and national sovereignty. The Act is nefarious and in one stroke the Indian State has surrendered the nation’s economic freedom to global money interests.

In a recent interview, the then Finance minister Yashwant Sinha, who introduced the Act, said he wanted a much tougher Act that could not be amended easily through the Finance Bill to meet yearly Government expenditure. He admitted that the standing committee under Shivraj Patil forced him to dilute some provisions, but the real core agenda under the mask of fiscal responsibility persisted in the final Act passed.

On the face of it, the FRBM Act seems to force prudent financial management of State finances, but under the mask of fiscal responsibility it fundamentally changed the role of the Indian state in the economy by compromising the State’s fiscal freedom to the Reserve Bank of India (RBI) and global money interests. It made the RBI the all-powerful overlord of the economy, unaccountable to either the State or the people.

The original FRBM Act is outright silly on its roadmap to eliminate revenue deficit and restrict fiscal deficit to 2% of GDP by 2006. The global financial crisis in 2007 forced the UPA government to suspend the silly revenue and fiscal deadlines of the Act, but it’s most lethal provision on Government borrowings is still in full force.

The Act prohibits the State from borrowing directly from the Reserve bank of India to meet its fiscal deficit needs. In other words, it eliminates whatever influence the Indian State has on the monetary system. The Act also prohibits the Reserve Bank of India from trading government securities in the primary market. The RBI no longer provides freshly minted money to cover Government fiscal deficit. The Government has to raise money from the market at high interest for fiscal deficit spending.

The Act has completely obliterated the authority of the Indian people over the monetary system. Now the money to catalyze growth in the economy has to come only from foreign investment. The economic growth achieved through private bank debt can only be sustained with a counterbalancing Government expenditure through fiscal deficit funded by the Central Bank with fresh minted money. The Government fiscal expenditure from printed money can balance the private debt created by the banking system for greater economic stability.

This Act severely constrains the Government role necessary to achieve balanced growth through investments in public infrastructure. The modern debt economy needs periodic Government stimulus to remain solvent and maintain growth. Fiscal deficit spending is an indirect means to transfer the overall debt in the economy from private participants to the Government to avoid the economy falling into a debt trap. With this Act only when foreign exchange reserves increase through foreign investment, foreign debt or foreign remittances, does the RBI release fresh money into the system.

The combined debt in economy, which includes government, business and household debt, cannot decrease while the economy achieves growth. Economic growth always increases total debt in the economy unless the growth is completely achieved through foreign investment outside the domestic banking system. Such foreign investment has to focus only on exports to achieve growth without adding to the debt in the economy.

The FDI-centric export oriented growth may not enhance debt in the economy but with a depreciated domestic currency it causes net drain of real wealth in the form of natural resources from the country. The country exports high value resources and imports low value resources for the same money with a depreciated domestic currency.

Imagine entire economic growth funded by such foreign investment at depreciated domestic currency. This process is continuous one way transfer of real resources from poor nations to the nations that fund such investment ironically through own fiscal deficits funded with printed money. The balance in economy achieved through symbolic high Government debt is better that drain of resources through “debt free” foreign investment.

Since economic growth only through foreign investment is impossible and a net loss to a nation’s economy and resources, a much bigger domestic investment, in proportion to the foreign investment that really helps the economy through technology transfer, is always needed for economic growth. This domestic private investment needs the support of Government fiscal deficit to sustain in a debt economy. It is the fine balance between Government and private debt that moves the economy forward with stability.

The farce of fiscal deficit management to control or reduce Government debt can only work for a short term when private debt is on the ascendant through increased lending by the banking system. When private debt inevitably reaches a tipping point with the economy in danger of tripping, Government would have to throw fiscal discipline to the winds and intervene through massive bailouts funded by printed money.

Through quantitative easing or other methods, which are just fancy phrases for accumulated fiscal deficit not spent during the fiscal discipline years, Governments that trumpet their fiscal discipline would finally end up rescuing chosen cronies or special interests in the economy. The bottom line of such measures is to transfer private debt to Government to restore balance in the economy. This is the crux of debt economy and its recurrent crisis.

A financial crisis precipitates when the proportion of public debt has to increase in the overall debt (public + private) equation to restore equilibrium in the economy. Even with all fiscal discipline increase in public debt to sustain the economy at some point in the economic cycle is inevitable; what is the real idea behind this fiscal conservative fundamentalism and different shades of so-called right-wing economic principles that promote it?

Fiscal conservatism ideologues don’t want the common economic participant to benefit through a smooth stable economy with necessary regular Government fiscal expenditure. They essentially want the smart and chosen few at the top to first squeeze and pillage common folks through private debt, economic monopolies with crony access to banking system and other economic institutions. After they triumph over everything else they would approach Government as too-big-to-fail entities for big fiscal spending only on them.

The FRBM Act prohibits borrowing from the RBI, restricts fiscal deficit and forces the Indian State to borrow funds from markets. The Government has to borrow funds at high cost for fiscal deficit funding; this can only lead to bigger revenue deficits. Government competition in the open market for capital at market interest rates would further drive the interest rates up making it prohibitive for small, medium and even large businesses to meet their capital needs at reasonable cost. The net effect is high interest rates in the economy.

Without the necessary fiscal deficit expenditure supported by the Central bank, the economy has to suffer lopsided growth, high interest rates, high levels of business and household debt. The balance sheet of the banking system would be out of balance, impacting lending activity which further drives down the credit creation in the economy. This would force domestic businesses to go after foreign debt and foreign investment. There is a reason why private foreign debt is high in the Indian economy.

The FRBM Act forces the Indian economy to look for foreign debt and foreign investment in domestic businesses through domestic high interest rates, credit and liquidity crunch. The real channel for money creation in the Indian economy after the FRBM Act is foreign investment and foreign debt. The FRBM Act by subverting the domestic monetary system has created a road map for increasing takeover of the Indian economy by global money.

The high foreign debt of Indian businesses and foreign investment in domestic businesses permanently pegs the Indian economy to global finance with ever increasing demand for foreign money in the economy. The energy of domestic entrepreneurs would serve the needs of global finance and the orientation of Indian economy has to be permanently export-oriented, causing net drain of domestic resources at much undervalued prices through exports.

Isn’t it a miracle achieved by global finance that it made poor nations believe that exporting their resources at dirt cheap prices to fund lavish lifestyles elsewhere is a sign of progress and prosperity? Isn’t a miracle that global finance convinced poor nations that their domestic printed money is bad and worthless and the money it prints is good investment?

The FRBM Act is an enormous gift to global finance from the Vajpayee government. After this Act, the government stake in even well-established profit making PSUs was brought down to fund their expenses or further expansion. The unaccountable RBI through interest rates is blackmailing the Indian State to cut down fiscal deficit. The sentiment of foreign investors and their return on investment matters more to the RBI than the economy’s domestic needs.

The FRBM is a serious act of violence against the Indian economy. In one stroke it has subverted the Indian monetary system and by extension national sovereignty to global finance. What is sovereignty without control over the monetary system? There are now serious attempts to destroy the PSU banking system. One way the Indian Government partially survived or delayed the calamity of this Act is through public sector banks and PSUs as the resources raised by PSUs don’t count under fiscal deficit of government.

The 2007 economic crisis forced UPA government to temporarily abandon the roadmap for revenue and fiscal deficit imposed by the FRBM Act, but the more deadly provisions on funding fiscal deficit and public debt are in full force. The FRBM Act fundamentally altered the structure of the economy in favor of global finance and it is an irony that this Act was passed by a Government that promised Swadeshi economy to get elected.

The current NDA government must rectify this deadly sin if serious about national sovereignty and also to achieve an independent economy with holistic growth.

References

Reserve Bank of India – Liabilities and Assets

https://www.rbi.org.in/scripts/PublicationsView.aspx?id=16484