Tuesday, August 7, 2012

Cutting fuel subsidy can cause 2.6% spike in inflation: RBI

New Delhi, August 6: Reserve Bank ofIndiaGovernor D Subbarao has said the proposed elimination of fuel subsidy can lead to a massive 2.6% spike in inflation, an assessment that makes it even more difficult for the government to bite the bullet.

While a hike in diesel and cooking gas prices may be long overdue, the government is hard-pressed to contain inflation ahead of crucial assembly polls inGujaratand Himachal Pradesh later this year. A hike in the price of diesel, which is used as fuel for transporting goods, immediately leads to a spiral in the wider economy.

Subbarao, who shared his assessment with Parliament’s standing committee on finance on Monday, pitched for a healthy single-digit growth coupled with low inflation. The RBI governor‘s approach was in stark contrast to the former economic advisor to the government, Kaushik Basu, who has said that the country can settle for an 11% inflation in the event of 10% growth. “The ideal situation would be a 7% growth and 5% inflation,” the RBI governor told the panel, as he appeared to emphasise on the need to contain price rise.

However, the government is not completely convinced with the central bank‘s approach. A recent note from the government to the parliamentary panel expressed its disquiet over the central bank’s decision to keep money supply tight. At the meeting of the standing committee, the panel’s chairman, Yashwant Sinha, said there was a difference in the approach of the government and RBI. The high subsidy bill and lower tax revenue have resulted in the government’s fiscal projections for 2011-12 going awry. The fiscal deficit during the fiscal was 5.8%, wider than the initial target of 4.6%.

In his presentation before the panel, Subbarao said that while liquidity was not an issue there was lack of appetite for investment. He agreed that deficient monsoon, high fiscal deficit, food inflation, suppressed inflation and rising global commodity prices posed a major challenge to the government. According to a member of the standing committee, the governor conceded that there was a sharp decline in investments. “It has now gone into the negative territory,” said a member, who did not wish to be identified.

What is adding to the problem is the reluctance of the banks to pump funds into the economy. “The banks have large exposures in depressed sectors such as power, fertiliser, civil aviation and real estate. How long can the banks go on extending loans to these sectors,” asked a member, who participated in the deliberations. Members of the opposition parties on the panel said the risk-averse approach of the banks was hurting critical sectors that require large investments.

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