Once upon an 8%

One, Chidambaram managed to convince the RBI that he was dead serious about keeping the fiscal deficit target at 5.3 per cent of the GDP for 2012-13, even as analysts were sceptical about this being possible. Observing the overall scepticism about the government's ability to cut expenditure, Chidambaram decided to become a bit aggressive and chose to publicly announce he would bring down fiscal deficit to 5.3 per cent. This was somewhat unorthodox as finance ministers normally show their hand only during the budget presentation. Chidambaram probably chose to do it in Hong Kong, one month ahead of the budget, to win the confidence of the global markets as well as of the RBI. This was his way of telling the RBI that the Centre was walking the talk on fiscal and other reforms.

The second factor that may have impressed the RBI was the government's decision to leave oil companies free to raise diesel prices in small doses over the next 24 months. Earlier, the RBI had been citing the Centre's inability to correct oil prices as one of the reasons for not being able to ease monetary policy. The UPA surprised everybody, including the RBI, with its decision to correct diesel prices.

The diesel price increase is important from another important perspective. India badly needs to discourage, through rational pricing, the consumption of oil products because of its ever widening current account deficit (CAD), which touched an unprecedented 5.4 per cent of the GDP in the second quarter of 2012-13. For the financial year 2012-13 the CAD is estimated to be very high, at over 4.5 per cent of the GDP. This is way higher than what the policy-makers regard as a safe current account gap (what India pays in foreign exchange minus what it receives from abroad annually).

... contd.

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