The rapid decline in fiscal health and deterioration in the external sector outlook has prompted the Reserve Bank of India (RBI) to ask the government to hasten domestic reforms to curb its subsidy bill and encourage renewed equity flows.
The soaring expenditure and a fall in revenue due to the economic slowdown, may raise the fiscal deficit by one per cent of gross domestic product (GDP), compared to the estimate in Budget 2011-12, RBI said in the monetary and macroeconomic review for the third quarter.
The government had targeted to contain the fiscal deficit at 4.6 per cent of GDP in FY12. RBI warned unless fiscal reforms were expedited, the Centre could miss the target of 4.1 per cent of GDP for 2012-13.
The improving fiscal situation in 2012-13 is contingent upon growth and on the progress in implementation of tax and expenditure reforms.
On the weak external sector conditions, RBI said the pressure on current account deficit (CAD) and its financing persisted through the third quarter of 2011-12. Capital inflows turned weaker.
CAD is expected to widen during the year, despite a faster rate of growth of exports compared with imports in April-September. The combined CAD for the April-September period widened to $32.7 billion (3.6 per cent of GDP) from $29.5 billion (3.7 per cent of GDP)
RBI said import demand remained strong, notwithstanding the depreciation in the rupee. This reflected the inelastic demand for oil and the increasing demand for gold. The composition of capital inflows shifted in favour of debt, with a rise in the proportion of short-term flows.
The rupee depreciation may improve inward remittances, and the current account deficit is likely to widen further in the third quarter.
It could possibly contract in the fourth, reflecting the seasonal pattern, leaving the full-year CAD wider. Also, with the rupee stabilising since the latter half of December, equity investment inflows have returned.
RBI said close monitoring of the short-term external debt was important in 2012-13. Recent capital account policy measures have stimulated debt capital flows in the form of investments by foreign institutional investors in debt instruments and deposits of non-resident Indians.
It would, however, be necessary to reduce dependence on debt inflows and accelerate reforms to ensure a revival of equity flows, as investors seek strong growth opportunities in an otherwise gloomy global environment.
