Large fiscal deficits make price control tough, says RBI

In an indirect warning to Delhi, the Reserve Bank of India (RBI) today said central banks could find it tough to maintain price stability if governments continued to incur large deficits.

Maintaining that price stability was necessary for financial stability, RBI’s Trend and Progress report, released this evening, said higher inflation could push up the yield curve, which could result in significant mark-to-market losses for fixed income instruments. This, in turn, had adverse implications on bank profitability, as banks had to benchmark their bond portfolio to the prevailing prices. Bond yields had an inverse relationship with prices.

Over the past 12 months, governments across the world have provided large booster doses to the economy to spur growth. This has resulted in higher deficits.
 

BENCHMARKING INDIAN BANKS (%)
	Return on assets	Gross NPLs #	CRAR	Provisions to NPLs	Capital to assets
India	1.0*	2.3	13.0	52.6	6.4**
Brazil	1.1	4.3	18.5	157.3	9.2
Russia	0.5*	7.6	18.5	90.8	13.6*
China	1.0*	1.8	12.0*	134.3	5.4
Mexico	1.2	3.8	15.2	143.7	9.1
South Africa	1.0	5.1	13.5	NA	7.9
USA	0.2	3.8	13.5	66.5	10.2
UK	(-0.5)*	1.6*	12.9*	54.6***	4.4*
Japan	0.2	1.7*	13.4	25.5	3.6*
Canada	1.3	0.9	10.3	29.8	5.8
* Data for 2008; ** 2007; ***  2006; # As % of gross advances NPL: Non-performing loans; CRAR: Capiral adequacy ratio  Source: RBI

In India, the stimulus packages have been partly responsible for a rise in the Centre’s fiscal deficit, which is projected to touch 6.8 per cent of the gross domestic product. Higher government borrowings, budgeted at as much as Rs 4,51,000 crore during 2009-10, have already resulted in the yield on 10-year government securities rising to 7.35 per cent.

Though RBI has in the past defended the stimulus packages, it has said the higher deficit has made the task of monetary management tougher. It has also suggested the government should return to fiscal consolidation at the earliest.