‘High level inflation erodes medium-term growth prospects'

Cautioning the government that excessive borrowing is bad, Reserve Bank of India Governor D. Subbarao on Wednesday urged the government to put a cap on the public debt as it would hurt growth.

“There is an inflexion point beyond which fiscal deficits militate against growth. Government borrowing is not bad per se, but excessive borrowing is. There is, therefore, a need to cap total public debt as a proportion of gross domestic product (GDP),” Dr. Subbarao said in an address at the International Research Conference here.

Stressing on the need for improving the quality of public expenditure, Dr. Subbarao said, “If the government borrows and squanders that money away on unproductive current expenditure, both fiscal sustainability and growth would be jeopardised.”

“Governments need to spend on merit goods and public goods, in particular on improving human and social capital and on physical infrastructure,” he added.

Responding to criticism that the RBI's decision to increase interest rates 13 times since March, 2010, has impacted growth, the RBI Governor said the policy action was “geared toward safeguarding medium-term growth even if it meant some sacrifice in near-term growth.”

An inflation rate above the threshold level of 4-6 per cent impacts growth adversely, he said, adding, “With inflation ruling above 9 per cent till recently, we were way past this threshold. At this high level, inflation is unambiguously inimical to growth; it saps investor confidence and erodes medium-term growth prospects.”

In his address, the Governor also called for a clear definition of boundaries for a central bank's responsibility toward sovereign debt sustainability.

A central bank, he said, should take the lead in ensuring financial stability, but not treat it as an exclusive subject. On the buy-back of gilts to inject over Rs.70,000 crore of liquidity into the system through Open Market Operations (OMOs), the Governor said it was a case of “acquiescence in fiscal dominance”.

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