High fiscal deficit restraining policy rate cut: RBI

The Reserve Bank on Tuesday suggested that the government should endeavour to contain high fiscal deficit, which has been restraining the central bank from lowering interest rates.

"In the absence of credible fiscal consolidation, the Reserve Bank will be constrained from lowering the policy rate in response to decelerating private consumption and investment spending," Reserve Bank Governor D Subbarao said after announcing RBI's third quarter policy review in New Delhi.

The RBI said that strong signs of fiscal consolidation are necessary to create a space for lowering policy rate without the risk of resurgent inflation.

"The forthcoming Union Budget must exploit the opportunity to begin this process (of fiscal consolidation), in a credible and sustainable way," Subbarao said.

He also made a case for freeing of diesel prices to control the subsidy burden.

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"As the food subsidy bill is expected to rise, it will be prudent to fully deregulate diesel prices to contain both aggregate demand and trade deficit," he said.

Even Finance Minister Pranab Mukherjee had last month said that the government's subsidy burden could exceed budgeted target by Rs 1 lakh crore (Rs 1 trillion) on account of petroleum subsidy.

"The gross fiscal deficit for 2011-12 will overshoot the budget estimate substantially," he said. The government pegged the fiscal deficit target at 4.6 per cent of the GDP for the current fiscal.

Subbarao said the slippage in fiscal deficit would add to inflationary pressure.

The RBI in its macroeconomic review of the economy released ahead of third quarter review of monetary policy had said that the higher expenditure on petroleum subsidy could drive up the fiscal deficit by around 0.8 percentage points of GDP for 2011-12.

The government will face additional pressures on account of food subsidies when the proposed Food Security Bill is enacted and implemented, it said, adding, the government needs to control its expenditure on petroleum subsidies.