Using forex reserves faces deficit challenge: PM

$5bn a year for three years to be used for infrastructure projects.

Prime Minister Manmohan Singh has said the government will assess the potential impact of a higher fiscal deficit before deciding on using foreign exchange reserves to fund infrastructure projects.

"Orthodox economists are opposed to the idea. Keynesians are more open to it because of the benefits it is likely to provide. But the fiscal deficit will go up. The issue of confidence is involved, which will have to be carefully considered," Singh told Business Standard on Saturday on the sidelines of a function organised by the Institute of Economic Growth and Academic Foundation to release a book of essays in honour of former Finance Commission Chairman AM Khusro.

Planning Commission Deputy Chairman Montek Singh Ahluwalia had proposed using about $5 billion a year for three years from the reserves on infrastructure projects.

This will require the government to deviate from the deficit reduction target set out in the Fiscal Responsibility and Budget Management Bill. Ahluwalia had argued that a temporary deviation was acceptable since the money would be used "to fill critical infrastructure gaps in the economy".

Economists, however, are not convinced. "It is an issue of macro-economic stability," said Subir Gokarn, chief economist, Crisil. The past few years have seen a moderate inflationary scenario with falling interest rates. Using the reserves will imply issuing domestic debt to buy reserves.

"This will impact either interest rates or inflation. If the Reserve Bank of India lends the money to banks or to others in the economy, it will increase liquidity and push up inflation. Right now, the inflationary impact is a big issue," he added.

Saumitra Chaudhuri, economic adviser, ICRA, said: "The Fiscal Responsibility and Budget Management Bill is a great institutional achievement. Manmohan Singh was the first to put fiscal consolidation on the front burner and he should stick to it."

The finance ministry and the Reserve Bank of India are believed to be against the idea of using forex reserves, at almost $125 billion on November 19. However, Finance Minister P Chidambaram has said the matter will be decided by the prime minister.