Breach of fiscal deficit target will have implications: RBI
The fiscal deficit target of 4.6 percent of GDP in 2011-12 could be missed and this will have serious implications on inflation, according to the Reserve Bank of India (RBI).
Mumbai: The fiscal deficit target of 4.6 percent of GDP in 2011-12 could be missed and this will have serious implications on inflation, according to the Reserve Bank of India (RBI).
"In 2011-12, developments so far indicate that the fiscal deficit target of 4.6 percent of GDP could be breached which will have implications for domestic inflation.
"The moderation in private demand resulting from anti- inflationary monetary policy stance of the RBI will be partly offset by the expansion in public sector demand in terms of the size of the fiscal deficit," RBI Deputy Governor H R Khan said.
Speaking at the 10th National Management Seminar in Bhubaneswar recently, Khan said while shrinking value of money on account of high price rise called for a tight monetary policy, there is also a need to maintain a balance between controlling inflation and boosting growth.
The transcript of Khan's speech was made available in the RBI's website on Monday.
The government has already admitted that adhering to the 4.6 percent fiscal deficit target would be a challenge on account of lower than expected revenue mop-up and the global financial crisis.
"Shrinking value of money because of persistent high inflation explains the importance of anti-inflationary monetary policy," the RBI Deputy Governor said.
Khan said for a country like India with a large percentage of population still living below the poverty line, inflation works as a regressive tax.
"Economic welfare of the population at large could be enhanced primarily through higher growth, that too in a low and stable inflation environment. That suggests why balancing growth and inflation becomes so important to monetary policy," he said.
Khan said inflation within the threshold level would not mean erosion in purchasing power since higher growth would also raise the income levels, resulting in increased net purchasing power.
"Unless the benefits of growth get equitably distributed, this net increase in purchasing power may not happen to all. At the aggregate level, some inflation that coexists with high growth could be welfare maximising.
"At high inflation, particularly above threshold level, growth may, however, moderate, and both high inflation and low growth could erode welfare," he said.
According to Khan, while the global commodity price index has gone up by more than 85 per cent between February 2009 to October 2011, Indian's Wholesale Price Index (WPI) during that period has risen by about 27.6 percent.
"That certainly has led to shrinking value of money. Some of the supply side pressures on the value of money however require better capacity to augment the supply situation.
"Moreover, wages in rural areas and staff remunerations in the corporate sector have grown at rates higher than the inflation experienced in the recent past. The erosion in purchasing power, therefore, is much less than what may appear only from the inflation numbers," he said.
Khan said recent evidence of growth moderation could be expected to dampen demand side pressures on inflation. He said that in the absence of major supply side risks from global commodity markets, inflation should moderate to about 7 percent by March 2012.
The RBI raised key-policy rates 13 times between March 2010 and November 2011 to curb inflation, before putting a pause to its monetary tightening stance at the mid-quarterly policy review last month.
Inflation has been near double-digit since December 2010.
However, food inflation entered negative zone in late last month and experts say that this will help pull down headline inflation to around 7 percent by the financial year-end.
India Inc has blamed the high interest rates, which have led to an increase in the cost of fresh borrowings, for hindering fresh investments and leading to industrial slowdown.
Economic growth during the second quarter (July-September) of the current fiscal slipped to 6.9 per cent, lowest in over two years. Industrial production entered negative zone and contracted by 5.1 per cent in October.
Regarding high food prices, which prevailed for most of 2010 and 2011, Khan said a number of factors was responsible for it.
This included demand-supply mismatch, increase in rural wages which led to growth in demand, increase in minimum support prices of some crops, high international prices and problems with the supply chain.
"High inflation is a risk to financial savings, since it can reduce the value of savings accumulated over the years. Making financial instruments available in the system that could provide an effective hedge against inflation assumes importance in this context," he said.
Khan added that the RBI, in consultation with the government, is exploring the possibility of issuing inflation indexed bonds (IIBs).