Fiscal Responsibility and Budgetary Management (FRBM) act has made fundamental changes in the realm of governance and brought prudence to government borrowings.It has made government realize that it cannot keep on borrowing unlimited amount of money and should encourage efficiency in the given means.It has also waded off the extreme risk of having a very high public debt and its jittery consequences on the economy.Further, it has brought confidence among global investors that inflation will remain manageable and their investment would be safe in emerging markets like India.

The implementation of this act, however, is bringing in lot of pain to public organisations as they are forced to cut salaries of their own staff and procrastinate contractual payments.This is happening because FRBM is only fixing the borrowing side and not the liability side.However, it is important to understand that smooth functioning of public organisations with limited borrowing capacity can happen only if they put a cap on their liabilities.Thus, there is a need to have a fresh review of public finances and address them to the core.

Poor public finances are having their roots in a set of misbeliefs. The most common one is that ‘Going concern’ status of the government gives a free ticket to take on unlimited liability by the government.This belief is pervasive among politicians, bureaucrats and contractors.Thus, there is continuous trend of floating new contracts even when funds are not available for the same.This has led to piling up of liabilities where contracts are in place even when no funds are available.Similarly, the staff cost has been increased without keeping budget grant in mind.The condition is that most of the states today are not even able to discharge their most basic liabilities properly.

The piling up of liabilities is creating an explosive situation where Government will face hard time to fulfill obligations it has made to its employees, pensioners and contractors.If government borrows more money to fulfill these obligations , it will only delay the problem to a stage of further crisis.Therefore, there is a need to draw a ‘Financial Laxman Rekha’ to save the government from falling into a debt trap.This can be done by introducing binding condition on government departments by including two new metrics-Liability Ratio and Liability Coverage Ratio. All the revenue funded organisations should observe an upper limit on Liability Ratio to be 3 and Liability Coverage Ratio to be no more than 1.25.

The concept of Liability Coverage Ratio is based on the fact that the ratio of Current year’s Liability should not be more than 1.25 times the available grant for the year.Thus, if the grant for the year is 1000 crores, the liability for that year should not exceed more than 1250 crores.The liability here means the left over value of live agreements that will accrue in this year.Similarly, a Liability Ratio of 3 means that at any point of time, the organisation should not enter into new contracts when the aggregate of their balance liability is more than 3 times the average budget grant i.e. for 1000 crore budget grant, the multi-year aggregate left over value of contracts should not exceed 3000 crores.Once, it hits 3000 crore, the organisation should not go into any new contract and if it is necessary to go into a new contract then the same should be done by sinking the existing liabilities.

Thus, the Liability Coverage Ratio will help in managing current year’s liability position whereas Liability ratio will put brake on reckless sanctioning of new projects without sinking the existing liability.These two metrics should be given a statutory status and should be adopted as early as possible by the public organisations to avoid a debt trap.These metrics have the potential to stop further deterioration of public finances and will push public finances into a trajectory of qualitative improvement .It will create an automatic liability control mechanism and will drive public organisations to spend the money more productively and only on the core areas.It will also clean the books of public organisations of unwanted contracts and help them prioritize their works.Thus, this is a Financial Laxman Rekha, perhaps, whose time has come and should be a part of fundamental reforms which India is pursuing in order to achieve higher level of growth and development.