Reserve Bank of India Governor D Subbarao said on Friday that another stimulus package could help the economy in the short-term but a sustainable recovery required the government to return to fiscal consolidation.
The governor's statement at a financial management conference came hours before the new government was sworn in. So far, the government and the central bank have announced two packages to boost economic activity in addition to tax cuts following the Interim Budget.
"Given the still soft economy, the pressure to provide more stimulus will persist," the governor added.
The packages had resulted in a sharp increase in government borrowing. "Large borrowings by the government run against the low interest rate environment that the Reserve Bank is trying to maintain to spur investment demand in keeping with the stance of monetary policy," Subbarao said.
Large borrowings translate into money, available with banks, flowing into government securities instead of being deployed for lending. "However, with every percentage point increase in the fiscal deficit, maintaining adequate liquidity in the system becomes that much more difficult. Managing this trade-off between our short-term compulsions and longer-term sustainability will be one of the big challenges going forward," the governor said.
During 2008-09, the Centre's gross borrowings went up from Rs 1,76,453 crore budgeted at the start of the year to Rs 3,42,769 crore, a 94 per cent rise. To ensure that the borrowings did not affect the markets, RBI and the government also unwound the bonds issued under the Market Stabilisation Scheme besides mopping up liquidity through open market operations. During 2008-09, the Centre's fiscal deficit was budgeted at 2.5 per cent of gross domestic product at the start of the year and was revised sharply to 6 per cent in the Interim Budget.
The fiscal deficit has grown mainly on account of a large loan waiver package for farmers, higher salaries to government employees and a nation-wide employment guarantee scheme.
Subbarao said RBI will continue to use a combination of monetary and debt management tools to manage the government borrowing programme.
While pointing out that sectors such as cement, steel and automobiles were showing signs of revival, Subbarao said India could see an economic turnaround later this year as the stimulus packages work through, provided the global economic environment improved. At the same time he said that the global financial outlook remained uncertain.
"These signs are not unambiguous--there is as yet no clear sign of export decline reversing the trend, and credit growth continues to be subdued," Subbarao said.
He added that RBI was in the process of setting up an inter-disciplinary Financial Stability Unit to monitor and address systemic vulnerabilities in the financial sector.
In his speech, the government also prodded banks to lower lending rates. "Although deposit rates are declining and effective lending rates are falling, there is clearly more space to cut rates given declining inflation. Making liquidity available in sufficient quantity, as RBI has done, should also help by giving confidence to banks of the availability of funds," he said.
