Kuala Lumpur: India’s government must find ways to rein in its huge fiscal deficit quickly to prevent inflation from spiralling out of hand if RBI is forced to help finance the gap, a government economic adviser said.
India’s budget deficit, expected to reach 6.8% of gross domestic product in 2009, its biggest in 16 years, will force the government to sell an unprecedented Rs4.51 trillion ($93.6 billion) of bonds in the current fiscal year.
“The most immediate risk is the large fiscal deficit, and the possible financing of the deficit by the central bank, which could lead to greater inflation,” Raghuram Rajan, economic adviser to Prime Minister Manmohan Singh, told the agency.
The government’s plan to cut fertiliser subsidies by providing them directly to farmers in the form of cash and its promise to align domestic fuel prices with international prices will help towards reducing the fiscal deficit, he said.
“The sooner this (fuel price alignment) is done, the more comfortable the medium term budget deficit will be,” Rajan said in an e-mail response to Reuters questions ahead of the World Capital Markets Symposium in Kuala Lumpur next month.
The government said after elections in May that it will consider a proposal to eliminate fuel subsidies as early as July in order to balance growth with fiscal prudence.
RBI left its short-term rates and banks’ cash reserve requirement unchanged as expected on Tuesday and stressed that its priority was to nurture growth, which has been hurt by the global downturn.
It said there were indications inflation may firm up by the end of the year due to increases in commodity prices and easy monetary and expansionary fiscal policies.
Official forecast put inflation at 5% by March next year, although private sector economists are expecting the figure at 6% to 7% due to higher costs of oil, food and other commodities.
“The greater risk for the medium term is that we see few reforms, and more populism ... India has to think about whether it can afford to open its purse so wide without growth,” said Rajan.
India’s budget, unveiled this month, failed to lay out firm plans to sell state-owned assets and ease foreign investment rules, economists said.
The government may partly fund its budget deficit from the sale of some state-held shares but overall, Rajan said he expected very little appetite for privatization.
“The Congress party is still in a coalition, and it has its own left wing, so I would not hold my breath waiting for outright privatization or labour market reforms,” said Rajan, formerly chief economist at the International Monetary Fund.
The $1.2 trillion Indian economy has expanded at a rate of close to 9% in the five years ended 31 March, but growth slowed to 6.7% in fiscal 2009.