The Fiscal Responsibility and Budget Management (FRBM) Act was enacted in 2003 which set targets for the government to reduce fiscal deficits. Looming threats of global recession, melting financial markets, and an impending domestic demand destruction pose difficult questions about possible policy responses in India. There is no doubt that till now, the policy focus has been to avert the health emergency caused by COVID-19 because otherwise, the economic emergency would be inevitable.

Challenges in easing the fiscal deficit target:

•  The government has already utilized the elbow room offered by the FRBM Act under exceptional circumstances in the FY20 and FY21 budgets, with the targeted budget deficits being 0.5% of GDP higher than the FRBM mandated ones.
• This leaves limited conventional fiscal space for any stimulus, but there could be a case for temporarily suspending the FRBM Act, as was done during the global financial crisis of 2008.
• In fact, given the recent trends, the FRBM Act-mandated maximum target of a fiscal deficit of 3.8% of GDP might have already been breached for FY20.

Reasons for need of a fiscal stimulus:

• With further fall in the tax collection by the Central Government, the devolution of funds to states by the Centre would also suffer.
• In view of the lockdowns, there could be little doubt that the GST collection, which constituted 70 per cent of the state’s tax collection, would plummet this year.
• The “lockdowns” and closure of businesses announced by various states to arrest the spread of Covid would severely restrict the capacity of states to mobilise resources.
• However, considering the grave situation, fiscal stimulus should not be deterred by FRBM considerations as now, growth concerns outweigh worries about future macro stability risks.
• The states have urged Prime Minister to allow states to borrow more by raising the limit set under the Fiscal Responsibility and Budget Management (FRBM) Act.

Measures needed for fiscal stimulus:

• Earmarking an enhanced budget for healthcare would definitely be the top priority.
• Income support to people whose livelihood has been impacted (these will primarily include daily wage earners in different industries, and services like construction, travel, etc). Direct cash transfer to this group is ideal, but might suffer from proper identification challenges.
• Packages for deeply affected sectors like travel and tourism (9.2% of India’s GDP) and MSMES could have three components—temporary postponement of taxes, cheaper loans, and explicit financial grants.
• Frontloading public spending to counterbalance near-term headwinds
• The government can also consider temporary suspension of long-term capital gains tax to incentivize flows back into the equity market in the short term.
• Funding a fiscal package: Even if the government limits the fiscal stimulus to 0.5% of GDP for FY21, there is likely to be a revenue slippage of 0.8% of GDP each from both tax, and non-tax revenue components in the current environment, making the overall fiscal requirement higher by more than 2% of GDP.
• The monetary response: Central bankers are trying to counter the two channels of transmission of the virus shock—financial stability risk arising out of large market dislocations, and growth risk from estimated disruption in economic activity.

An early assessment and acknowledgement of the extent of demand destruction (both global and domestic) is the need of the hour. Faced with significant uncertainty over the depth and duration of the negative shock, policymaking should be extremely quick and innovative. The fiscal package should, ideally, be proactive (not waiting for signs of growth slowdown in high frequency data), quickly implementable (for a change, revenue expenditure should get priority over capital expenditure), sizeable (at least 0.5% of GDP), targeted (urban might need more support than rural in initial stages), and reversible.