Put finances in order, RBI tells govt

Voicing an urgent need for fiscal consolidation, the Reserve Bank of India (RBI) today warned that a large fiscal deficit might hit growth.

The central bank also asked the government to spell out steps to withdraw (in phases) the stimulus package put in place last year to contain the effects of the global financial crisis.

It also sought coordination between steps the government might take to reverse fiscal sops and its (RBI’s) withdrawal of a loose monetary policy. “The reversal of monetary accommodation cannot be effective unless there is a rollback of government borrowing,” RBI said.

The economy is in a better shape now compared to a year ago, when RBI and the government were working together to contain the effects of the global financial crisis. The counter-cyclical public policies were necessary to manage the crisis. Indeed, they were critical to maintain demand, as other drivers of demand had weakened, RBI said.

The government had cut excise duties, gave interest rate subventions and increased capital expenditure in the second half of 2008-09. This came on the top of structural measures built into the Budget, including the Sixth Pay Commission award and the farm debt waiver.

The government borrowing increased abruptly in 2008-09 and 2009-10. It was managed through a host of measures that bolstered liquidity.

Those liquidity infusion options will not be available to the same extent next year (2010-11). Plus, there would be additional constraints, RBI said. Inflationary pressures would remain and private credit demand would be stronger with the threat of crowding out becoming quite real, it said.

Referring to fiscal consolidation, RBI said it could begin with a phased rollback of the transitory components of the stimulus package.

The government should indicate a road map for consolidation and spell out the broad contours of tax policies and expenditure compression that would define the road map, it said.

“We will have to await the forthcoming Budget in February-end for the government's decisions on phasing out the transitory components of the stimulus,” RBI added.

As regards the structural components, even though they were one-off, some of the impact is expected to continue over the next couple of years, as state governments and public sector enterprises align their pay structures with the recommendations of the Sixth Pay Commission.

A consolidating recovery should encourage us to clearly and explicitly shift our stance from ‘managing the crisis’ to ‘managing recovery,’ RBI said. The growing confidence in the recovery justified our moving further in reversing the crisis-driven expansionary stance, RBI said.

“Our main policy instruments were currently at levels more consistent with a crisis situation than with a fast-recovering economy. It was, therefore, necessary to carry forward the process of exit further,” it said.