A roadmap for fiscal consolidation and a significant tax reform are needed

Days ahead of the mid-quarter review of the monetary policy, on December 18, Reserve Bank of India (RBI) Deputy Governor Subir Gokarn on Saturday said inflation continued to be the primary concern for the central bank.

His comments come amid growth in the second quarter (July-September) falling to 5.3 per cent, triggering demands for a rate cut by the RBI to boost the economy.

The RBI should not do anything that provide some short-term stimulus to growth, he said at a Bombay Management Association event.

“One action is not necessarily going to make the difference. But there are risks associated as well,” Mr. Gokarn said, adding inflation continued to be the primary concern of the monetary policy.

According to many analysts, the central bank will hold the rates on December 18 as inflation continues to be high, at 7.45 per cent in October.

At the last policy announcement, the RBI had left the short-term lending rates unchanged at 8 per cent.

Mr. Gokarn said the RBI should not fall prey to trying out something opposite if one set of actions, in this case the anti-inflationary stance, was not working.

“The belief that just because something does not seem to be working, the exact opposite is the solution (is incorrect),” he said.

On Thursday, the RBI Governor, D. Subbarao, had hinted that rate cuts were on the anvil as growth had moderated steeply.

“We are expecting that inflation will trend down starting Q4. As we go into our mid-quarter policy on December 18 and the quarterly policy on January 29, we will take into account the growth-inflation trajectory and calibrate our monetary policy accordingly,” the Governor had said.

Above comfort level

However, Dr. Subbarao also said at 7.5 per cent, inflation was still high, though it had come down from its peak.

To tame inflation, the Reserve Bank since March 2010, has announced 13 consecutive rate hikes. However, inflation is still above the RBI’s 5 per cent comfort levels.

Mr. Gokarn said a commitment to walking on a fiscal consolidation roadmap and introducing tax reforms such as Goods and Services Tax (GST) would help the country avoid a downgrade by global rating agencies.

“A roadmap for fiscal consolidation, a significant tax reform (GST) are what we need in terms of giving some comfort on where the fiscal situation is headed, as it creates some resources available for government investments.

“And certainly, if this roadmap is adhered to, then I think the rating downgrade risk is sort of automatically dealt with.”

Noting the positive impact on state finances when VAT was introduced, he said GST would have a similar impact.

“The VAT had tremendously helped the states in reducing their fiscal deficits, and the same kind of dividend is possible with GST as well,” he said, without elaborating further.

Fiscal deficit

On the fiscal deficit, the RBI Deputy Governor underlined the need to invest in capital formation.

Mr. Gokarn said during high growth period of 2004-07, there was a lot of focus on capital formation and the work done on building highways is so far helping the economy.

Talking of the volatile rupee, he said the currency was fanning inflation but also conceded that it was very difficult to protect rates given the relatively small forex reserves and the high current account deficit.

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