Ahead of the Union Budget for 2011-12, the Reserve Bank has warned that delay in hiking the prices of petroleum products and fertilisers will adversely impact the government's ability to reduce fiscal deficit.
"Rising oil prices will impact prices of both petroleum products and fertilisers. If the government chooses to restrict the pass-through of consumers and farmers, it will have to make adequate budgetary provisions, which will constrain its ability to reduce the fiscal deficit," the RBI said in its third quarter monetary policy review.
The government started fiscal consolidation in the last Budget, when it proposed to reduce fiscal deficit from 6.8% of GDP to 5.5% in the current fiscal.
The fiscal deficit went up from 6% in 2008-09, to 6.8% in 2009-10 on account of stimulus provided by the government to the industry to combat the impact of the global financial meltdown.
The 13th Finance Commission has recommended that fiscal deficit be brought down to three % by 2013-14.
However, oil prices which are at over two-year high of USD 90 a barrel will put pressure on inflation as well as the fiscal deficit.
The oil marketing companies have raised the petrol price, which was decontrolled last year, by Rs 2.50 a litre earlier this month. However, the government did not allow any increase in prices of diesel despite demands from the oil retailers.
The finance ministry officials are firming up the proposals for the Budget for 2011-12 fiscal, which will be unveiled by Finance Minister Pranab Mukherjee on February 28.
The RBI said if the government does not make up for the rising global oil prices, inflationary expectations will rise and managing it would become difficult.
"...If it does not (the government restrict pass through to consumers) either fiscal credibility will be undermined or inflationary expectation will be reinforced by the likelihood of higher prices of these key inputs, both of which will further complicate inflation management," RBI said.
It has upped inflation projection for the current fiscal to 7%, from the earlier estimates of 5.5%.
"Fiscal consolidation is important for several reasons, including the fact that monetary policy works most efficiently which delaying with an inflationary situation when the fiscal situation is under control," RBI said.
It added that rising commodity prices will pose significant risk for fiscal consolidation in the year ahead.
It said the recent improvement in fiscal situation is because of the revenue from 3G spectrum auction and proceeds from disinvestment.
"However, fiscal consolidation based in one-off receipts is not sustainable," RBI said.