Finance Minister Arun Jaitley is slated to present the Budget for financial year 2016-17 next month.
"Relaxing the fiscal deficit (is the) key" because of the implementation of the pay panel's proposals which are likely to set a 0.7 percent hole in the government finances, foreign brokerage Bank of America Merill Lynch said today.
Finance Minister Arun Jaitley is slated to present the Budget for financial year 2016-17 next month. "We expect the 0.7 percent of GDP stimulus from the 7th Pay Commission to boost consumption from the second quarter of 2016. It's pre-condition that Jaitley relaxes the FY17 fiscal deficit target to 3.9 percent of GDP - same as FY16's - from the pre-committed 3.5 percent," it said.
Under a medium term fiscal consolidation plan, the government is committed to get the fiscal deficit down to 3 percent by 2017-18. It had already taken a relaxation for 2015-16 to support growth and under the revised plan, it has to achieve 3.5 percent in 2016-17.
The fiscal deficit stokes inflation and also crowds out private investment, and hence, is a key number monitored by both the RBI as well as the international rating agencies.
BofAML sought to downplay the negative effects, saying the gap is "well below" the medium term average of 4.8 percent since FY2000. The stimulus received from the 7th Pay Commission, along with lending rate cuts and a rollover of foreign deposits taken in 2013, will help the GDP growth to accelerate to 7.7 percent in FY17, it said. The government had last month cut its FY16 growth estimate to 7-7.5 percent.
Reserve Bank of India Governor will not cut by more than 0.25 percent at the upcoming policy review on February 2, the note said, adding that it expects another 0.50 percent in cuts in
April-September 2016 to support growth.
It said the fears of the government crowding out private sector are also "overdone", adding that it will have to increase borrowing by 13.6 percent to Rs 5,530 billion in 2016-17.
There is "undue stress" on reforms for pushing growth, it said, adding that it supports GDP expansion over a longer 5-10 year period, whereas the current challenge is a cyclical recovery.