The new finance minister will have a difficult time convincing the Reserve Bank (RBI) to expand the fiscal deficit to spur spending in the economy. RBI governor D Subbarao said at a financial management seminar on Friday that the heavy borrowing programme of the government has reduced the space for keeping interest rates low in the economy.
At the same time the governor acknowledged there was a need for the government to spend more to push growth. ?The first order of economic business for the new government will be the full Budget. Given the still soft economy, the pressure to provide more stimulus will persist. While this may help in the very near term, the sustainability of the recovery requires returning to responsible fiscal consolidation.?
According to Subbarao, the Indian economy would record a 6% growth rate in 2009-10. He said the economy is likely to recover from the impact of the financial meltdown later this year as stability gets restored in world markets.
Subbarao said the central bank has managed the government?s large borrowing programme in an orderly manner so far. ?But with each percentage point increase in the fiscal deficit, maintaining adequate liquidity in the system becomes that much more difficult. Managing this trade-off between our short-term compulsions and longer term sustainability will be one of the big challenges, going forward,? he said. The government plans to borrow Rs 3,62,000 crore from the financial markets in 2009-10, going by the interim Budget.
During the fiscal first half, the planned open market operations and unwinding of cash from the government reserves through the market stabilisation scheme will be the equivalent of a reduction of cash reserve ratio by three percentage points. ?This should leave adequate resources with banks to expand credit,? he said. But for policy-makers, he said, the challenge would be to unwind the measures taken during the crisis time, though it will be less painful for India compared with other countries.
?In India, monetary transmission has had a differential impact across different segments of the financial market. While the transmission has been faster in the money and bond markets, it has been relatively muted in the credit market on account of several structural rigidities,? he said. He noted that while overall industrial production fell again in March, cement and steel production has shown some preliminary signs of upturn.
Segments in the automobile sector, particularly two- and three-wheelers and passenger cars are ?showing a modest revival of demand. The industrial and business outlook is improving,? he said.