RBI less critical of govt, but unconvinced of its targets

The Reserve Bank of India (RBI) may have been less critical of the government in its latest monetary policy state, but it also appears that the central bank is not convinced of the fiscal targets set by the finance ministry. Or perhaps, RBI may be waiting for signs of the government’s fiscal policies working, before signaling lower interest rates.

On Monday, Finance Minister P Chidambaram outlined a 5-year fiscal consolidation roadmap, based on the Kelkar Committee recommendations. Among other things, fiscal deficit target for the current year has been revised to 5.3% from 5.1% earlier, and current account deficit target has been pegged at 3.7% of GDP, or roughly USD 70 billion. The plan has been criticized by economists as lacking in details, especially on controlling subsidies. And the RBI appears to share that view.

Here is what the RBI has to say about fiscal deficit.

"During April-August, the Centre’s fiscal deficit was nearly two-thirds of the budget estimate for the year as a whole. In view of evolving patterns of revenues and non-plan expenditure, the revenue deficit (RD) and the gross fiscal deficit (GFD) for 2012-13 are expected to be higher than budgeted ."

And unless fiscal deficit is brought under control, monetary easing would be of little help, the central bank thinks.

"A persistently large fiscal deficit reduces the space for a revival in private spending , particularly investment spending, without quickly re-kindling inflationary pressures."

Chidambaram estimates the current account deficit (difference between foreign capital inflows and outflows) to be around USD 70 billion, and is confident that it can be financed through foreign institutional invests, foreign direct investments and external commercial borrowings.

But the RBI is not sure if it will be that easy to bridge the gap in foreign capital flows, given the fragile global macro-economic environment.

"Global growth prospects have deteriorated further and downside risks have increased, even as monetary policy in advanced economies remains supportive. A large current account deficit poses challenges for financing it in the current global environment . In a situation of volatile capital flows, the deficit could exacerbate downward pressures on the rupee."