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Subbarao emphasizes need to cap fiscal deficit for economic stability

02 Feb 2012 Evaluate

With the Union Budget on the anvil, the RBI Governor, Duvvuri Subbarao has emphasized the need to cap fiscal deficit for economic stability. Without being specific to the Indian government’s borrowing, the Governor said that beyond a point, borrowings militate against growth. Therefore it is important that fiscal deficit be maintained at the right levels of GDP. Moreover, the Government needs to spend these funds on merit goods and public goods, particularly on building physical infrastructure and improving human and social capital rather than on unproductive current expenditure.

The RBI Governor further emphasized that as countries, we need to learn from the Euro zone crisis. Greece, Portugal, Italy and Spain and many other euro zone countries were on the brink of defaulting on their loans, as they had borrowings in excess of 100% of their GDPs. The ongoing recession had made matters worse for these economies as government revenues had reduced.

The aforementioned comments assume importance in the Indian context, as India's public debt to GDP is estimated at 65%, the second highest among emerging markets, behind Hungary. They have also come right before the announcement of the budget. The fiscal deficit in 2011-12 is expected to exceed the budget estimate of 4.6 % of the GDP on account of subdued receipts and overshooting of the subsidy bill by at least Rs 1 lakh crore. To bridge the receipt-expenditure gap, the government plans to exceed its borrowing target for the current fiscal by Rs 92,000 crore, taking the government’s borrowings to a total Rs 5.1 lakh crore. Yields on the government bonds had recently shot up to close to 9% levels following the announcement of upward revision in market borrowing programme.

The RBI chief pointed out the need for conducting open market operations (OMOs), and said that OMOs are motivated by the objective of easing liquidity or reducing the yields on bonds for debt sustainability. In the presence of large sovereign borrowing that makes the Government's fiscal stance unsustainable, central banks typically have little choice. If the central banks do not conduct OMOs to bring systemic liquidity within reasonable limits, they risk losing control over financial stability. In India, however, the question is whether the OMOs are acting as a disincentive for fiscal discipline.

Since November, RBI has bought Rs 70,000 crore of government bonds via OMOs - a move that helped in cooling off the yields. This week, the central bank will be conducting an OMO to buy government bonds worth Rs 10,000 crore. This is despite a cut in cash reserve ratio by 50 basis points that released Rs 32,000 crore of liquidity in the system. Liquidity conditions continue to remain under pressure, as reflected in the repo borrowings by banks and the elevated overnight call money rates.

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Subbarao emphasizes need to cap fiscal deficit for economic stability

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