The Reserve Bank of India (RBI) said a sustained commitment to contain fiscal and current account deficits was needed to create room for monetary easing, a day before it is widely expected to cut interest rates for the first time since April (full statement).
While the near-term risks to a bloating fiscal deficit have waned following the government's recent policies to stick to its fiscal deficit target of 5.3 per cent of GDP, sustainable fiscal consolidation would require cuts in subsidies.
"As reforms get executed, monetary policy could increasingly focus on growth revival," the Reserve Bank of India said in its quarterly report on macroeconomic and monetary developments on Monday.
The RBI added that even if inflation recedes further, the wide current account deficit may slow the pace of monetary policy easing. The current account gap had touched a record high of 5.4 per cent in July-September and is likely to rise further in the December quarter, it 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 per cent from 5.7 per cent previously. In October, the central bank lowered its own forecast for 2012-13 growth to 5.8 per cent from 6.5 per cent.
The survey also revised down the average wholesale price index inflation forecast to 7.5 per cent from 7.7 per cent. In October, the RBI had forecast that inflation would be running at 7.5 per cent by March, though December's rate of 7.18 per cent was the lowest in three years and better than the bank had expected.
The RBI is expected to reduce the policy repo rate by 25 basis points to 7.75 per cent in a policy review on Tuesday, making its first cut in nine months, economists polled by Reuters said earlier this month.
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