RBI says India needs fiscal consolidation for monetary easing

 (Reuters) - The RBI said a sustained commitment to contain the fiscal and current account deficits was needed to create room for monetary easing, a day before a policy review that is widely expected to deliver the first interest rate cut in nine months.

While measures taken by the government to bring the fiscal deficit within a targeted 5.3 percent of GDP have reduced near term risks, cuts in politically sensitive subsidies were needed for sustainable fiscal consolidation, the Reserve Bank of India said in a quarterly report on the economy released on Monday.

"Monetary policy needs to continue to be calibrated in addressing growth risks as inflation remains above the Reserve Bank's comfort level and macro economic risks from twin deficits persists," the report warned.

"Fiscal risks have somewhat moderated in 2012/13, but a sustained commitment to fiscal consolidation is needed to generate monetary space," it said.

The RBI added that even if inflation recedes further, the wide current account deficit may slow the pace of monetary easing, indicating a probable aversion to making deep cuts in rates that are among the highest of the major economies.

"One cannot expect significant easing from the central bank after reading today's review." said Rupa Rege Nitsure, chief economist at Bank of Baroda in Mumbai.

Thirty of 40 economists expect the RBI to reduce its policy repo rate by 25 basis points on Tuesday from 8.0 percent currently, a Reuters poll earlier this month showed.

Saugata Bhattacharya, chief economist at Axis Bank said: "I think RBI is being very cautious. The current account deficit has potential to create imbalances."

The current account gap had touched a record high of 5.4 percent in July-September and is likely to rise further in the December quarter, the RBI said.

The RBI also said its survey of professional forecasters had lowered the growth forecast for the 2012/13 fiscal year ending March to 5.5 percent from 5.7 percent previously. In October, the central bank lowered its own forecast for 2012/13 growth to 5.8 percent from 6.5 percent.

GDP growth that once looked set to hit double-digits has been stuck below 6 percent for the past few quarters and is poised to post its weakest growth in a decade.

That is too slow for a country with hundreds of millions of poor and worrying for Prime Minister Manmohan Singh as the ruling Congress party prepares for an election next year.

While the RBI has resisted the clamour from the business world and government to lower rates to boost the economy over the past nine months, the central bank has said it could ease policy during the current quarter.

Slowing inflation and recent reforms to contain the fiscal deficit and attract foreign investment was expected to help persuade the RBI to make its first reduction in the key repo rate in nine months, but any cut is likely to be modest.

In December, the headline inflation rate fell to its lowest level in three years, with the wholesale price index (WPI) rising an annual 7.18 percent. RBI Governor Duvvuri Subbarao, however, has since cautioned that inflation remains high.

The RBI survey also revised down the average wholesale price index inflation forecast to 7.5 percent from 7.7 percent. In October, the RBI had forecast that inflation would be running at 7.5 percent by March.