Pointing to the risk of high fiscal deficit pushing up inflation, the Reserve Bank of India (RBI) on Tuesday said the central government would need to improve the quality of expenditure to contain demand in the economy.
The large fiscal deficit has been a key source of demand pressures. Fiscal consolidation is, therefore, critical to managing inflation, RBI said in the first quarter review of its monetary and credit policy for 2011-12.
Resource allocations to address supply bottlenecks in food and infrastructure can support RBI’s efforts to achieve low and stable inflation.
RBI said there was still an element of suppressed inflation in the economy. Despite the recent increase in administered fuel prices, under-recoveries for subsidised fuel are estimated at over Rs1 trillion (one per cent of gross domestic product, or GDP). The government may have to fund a major portion of this subsidy bill.
Regardless of how this issue is handled, it will impact inflation. If the government hikes administered prices, the inflation implications are straightforward. If the government decides to absorb this in the fiscal accounts, the resultant expansionary impact will add to inflation pressures.
