New issues in Indian macro policy.

Table 5 Consolidated fiscal surplus in countries with an S&P long-term foreign currency
rating of BBB

Source: Sovereign risk indicators, Standard &
Poors, 8 January 2007.

Both these aspects can be addressed by moving forward to a new FRBM-II formulation,
involving three key elements:

1. The limit for the consolidated deficit of the centre and states needs to be pushed
downwards to a value near 3% instead of the existing 6%, so as to assure a declining
debt/GDP ratio at all times. Through this, India would rise up from the bottom
when international comparisons of deficits are made.

2. Fiscal rules should require that budgets are formulated with a target of a consolidated
deficit of 1% of GDP.

3. In the event that business cycle conditions prove to be difficult, the fiscal rules should
permit a slippage going up to 3% of GDP. Through this, fiscal policy would be
stabilising, yielding a consolidated deficit of near 1% when times are good but going
down to 3% in a recession.

Such a framework addresses numerous problems. It eliminates the possibility of an
increasing debt/GDP ratio that can arise with a consolidated deficit of 6% of GDP. Fiscal
policy would be stabilising, because there is a provision through which a budgeted deficit
of 1% (summing across centre and states) can enlarge to 3% owing to lower tax revenues
and higher expenditures. At the same time, this would be done in a way which preserves
the credibility of the fiscal rules.¹⁴

¹⁴For a proposal to explicitly put the debt/GDP ratio into the fiscal rule, see Mistry (2006).

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