High fiscal deficit rules out stimulus

Reserve Bank of India (RBI) Governor D Subbarao has ruled out the possibility of a fiscal stimulus, noting the Budgetary deficit was high. In addition, the central bank said, the large current account deficit being financed by debt threatened long-term sustainability.

In the foreward to the Financial Stability Report issued by RBI today, Subbarao said the large fiscal and current account deficits were serious concerns.

“The already high fiscal deficit leaves little room for the government to stimulate the economy,” he said.

The report says fiscal risk rose during the last financial year. “Trends in the various components of the fiscal deficit of the Centre throw up some disquieting features in terms of the elevated share of revenue expenditure in total expenditure and declining share of capital expenditure in total expenditure,” it said.

RBI said the persistently high subsidy burden was crowding out public investment, especially at the current juncture when private investment was slowing. “There is another concern, that the gross fiscal deficit of the Centre continues to be predominantly structural rather than cyclical,” it said.

The proposed fiscal consolidation in 2012-13 is primarily based on revenue-raising efforts of the central government but, said the central bank, containing subsidies within the stipulated cap of two per cent of gross domestic product (GDP) will be crucial for achieving fiscal consolidation.

On the external front, all the key vulnerability indicators — the reserve cover of imports, the ratio of short-term debt to total external debt, the ratio of foreign exchange reserves to total debt, the debt service ratio and net international investment position-GDP ratio — had deteriorated, RBI said.

“The risks to financing the CAD (current account deficit) have intensified in recent months. Global developments such as deleveraging by European banks have affected capital flows, especially to emerging markets like India. The moderation in capital inflows has necessitated financing of the CAD by drawing down foreign exchange reserves in recent quarters. This has weakened the external sector resilience of the economy,” it said.

However, recent measures to encourage capital inflows such as deregulation of non-resident external/non-resident ordinary deposit rates and raising the interest ceiling of foreign currency convertible bonds are expected to provide a reprieve to the pressures on the external sector, it added.