India Must Cut Deficit Starting Next Year, Panel Says

Feb. 19 (Bloomberg) -- India must cut its 16-year high budget deficit starting next financial year to make monetary policy effective in damping inflation, the Prime Minister’s Economic Advisory Council said.

“The government cannot continue with the kind of large revenue and fiscal deficits recorded in the last two years and will have to initiate fiscal consolidation in the coming fiscal year itself,” the panel said in a report in New Delhi before Finance Minister Pranab Mukherjee’s federal budget on Feb. 26.

Central bank Governor Duvvuri Subbarao last month said monetary policy alone won’t be effective in containing inflation unless Mukherjee withdraws fiscal stimulus measures and narrows the difference between spending and revenue. The Reserve Bank of India needs to move to “a neutral monetary policy as quickly as possible” as the economy recovers, Chakravarthy Rangarajan, chairman of the panel, told reporters today.

“It is necessary to initiate measures towards fiscal consolidation in the forthcoming budget to ensure fiscal sustainability and enable greater flexibility in monetary policy calibration,” he said.

India’s 10-year bonds headed for a fourth weekly decline, the longest losing streak since October, on speculation the government will increase its debt sales from a record. The yield on the 6.35 percent note due January 2020 rose two basis points this week to 7.89 percent as of 2:34 p.m. in Mumbai.

‘Bigger Risk’

Mukherjee may propose to borrow as much as 4.60 trillion rupees ($99 billion) in the next fiscal year, said Sanjay Arya, treasurer at state-owned Bank of Maharashtra in Mumbai. Gross borrowing next year may be “slightly lower,” said Rangarajan, who served as a central bank governor between 1992 and 1997.

Central bank Governor Duvvuri Subbarao on Jan. 29 called the budget deficit a “bigger risk” to India’s economy than any other factor. The government can shrink the gap by reducing expenditure and subsidies, Rangarajan said.

The central bank last month raised India’s growth forecast to 7.5 percent in the year ending March 31, and its end-March inflation forecast to 8.5 percent from an earlier 6.5 percent. Subbarao also increased the proportion of deposits lenders need to maintain as cash reserves to 5.75 percent from 5 percent.

The prime minister’s advisory panel today forecast a 7.2 percent economic expansion in the year ending March 31. It expects growth to accelerate to 8.2 percent next year and 9 percent the following year. Low farm and power output are constraining growth, according to the report.

Mukherjee has undertaken to trim the budget deficit to 5.5 percent of gross domestic product in the year ending March 31, 2011, from an estimated 6.8 percent this year.