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All you wanted to know about ‘escape clause’

Satya Sontanam | Updated on February 10, 2020 Published on February 11, 2020

Ever been boxed into a tight corner, only to find a small escape route? Well, the Finance Minister used just such an escape route in her Budget maths for FY20, by saying she was taking a deviation of 0.5 percentage points from the fiscal deficit targets set out earlier. She pegged the revised estimates of fiscal deficit as a percentage of the GDP for FY20 and FY21 at 3.8 per cent and 3.5 per cent, respectively.

This was widely reported as the government invoking the ‘escape clause’ to relax fiscal deficit targets.

What is it?

‘Escape clause’ generally refers to a contract provision that specifies the conditions under which a party can be freed from an obligation. The escape clause under the FRBM (Fiscal Responsibility and Budget Management) Act details a set of events in which the Central government can deviate from fiscal deficit targets. The fiscal deficit is the total amount by which the government’s expenses for a year exceed its revenues.

Escape clauses provide flexibility to governments to overshoot fiscal deficit targets in times of need, enabling them to respond to economic shocks. To ensure escape clauses are not misused, they are generally allowed only in exceptional circumstances, and with a check on the quantum of deviation.

In 2017, the FRBM Review Committee headed by NK Singh said that the exceptional circumstances cited in the FRBM Act, 2003 were defined opaquely and were liable to misuse. In 2018, the FRBM Act was amended to specify three conditions upon which the escape clause can be invoked. First, over-riding considerations of national security, acts of war, and calamities of national proportion and collapse of agriculture severely affecting farm output and incomes. Second, far-reaching structural reforms in the economy with unanticipated fiscal implications. Three, a sharp decline in real output growth of at least 3 percentage points below the average for the previous four quarters. The FRBM amendments also mentioned that the deviation from the stipulated fiscal deficit target must not exceed 0.5 percentage points in a year.

In the recent Budget, the government seems to have invoked the second condition. The quantum of deviation taken was the upper end of the limit — 0.5 percentage points. Do note that the term ‘escape clause’ is not used in the FRBM Act, but only in the FRBM Review Committee report.

Why is it important?

For any country, the costs of not adhering to fiscal deficit targets can be substantial. The review report on FRBM pointed out that the years after global financial crisis, when India did not adhere to the envisaged path of fiscal consolidation, were associated with macroeconomic instability, pushing the economy to the brink during the ‘taper tantrum’ crisis of 2013. But when economic activity is going through a lean patch and there isn’t enough demand, it may become necessary to use fiscal policy to engineer a revival.

The FRBM review committee was constituted to understand fiscal issues and lay down a framework on deviations. Some of the provisions related to the escape clause in the FRBM Act today are in line with the Committee’s recommendations. But a big miss is the suggestion that the government set up an independent Fiscal Council that could monitor the implementation of the FRBM and advise invocation of the escape clause.

That said, the roadmap for returning to long-term fiscal targets has been laid out in the Medium Term Fiscal Policy cum Strategy Statement, which is part of Budget documents.

Why should I care?

Invoking of the escape clause has its pros and cons. On the plus side, it creates extra elbow room for the Centre to boost a slowing economy by clearing its dues to businesses, paying more to staff or awarding new projects. On the other hand, the resulting higher borrowings can mean more debt and a higher interest outgo, which can cost taxpayers dearly in the long run.

The bottomline

We’ll have to wait and see if invoking the fiscal escape clause helps India escape the grip of the slowdown.

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Published on February 11, 2020

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