High deficit not a concern for rates - Montek

Planning Commission deputy chairman Montek Singh Ahluwalia speaks during a business conference in New Delhi in this March 27, 2009 file photo.

MUMBAI (Reuters) - A higher-than-normal fiscal deficit should not be a concern for interest rates if government spending bridges the gaps in private investment, a policy adviser said on Tuesday.

Montek Singh Ahluwalia, the deputy chairman of the Planning Commission, also said the country would require more stimulus even if it means widening the fiscal gap.

High borrowing costs and the global slowdown have hit Asia's third-largest economy harder than expected, forcing the government to step up market borrowings to support stimulus spending.

This has pressured interest rates even after the Reserve Bank of India (RBI) aggressively cut its key lending rate by 425 basis points between October and April.

"I think clearly what will happen to the interest rates actually depends on the stance of the monetary policy and also to some extent on whether the fiscal deficit is only replacing private replacement demand," Ahluwalia told reporters.

"If private investment demand is low and fiscal deficit expands to fill that gap it should not affect the interest rates."

In February, the government set a fiscal deficit target of 5.5 percent of gross domestic product for 2009/10 (April/March), lower than 6.2 percent in the previous year, but the borrowing target has been increased to 3.62 trillion rupees ($74.5 billion) for this year from 3.06 trillion last year.

The need for more stimulus and pledge to keep poll promises of cheaper grains and other welfare schemes have sparked fears the government may breach the fiscal deficit and the borrowing target again this year.

"I will not recommend going back to FRBM (fiscal responsibility and budget management Act target) in a hurry," Ahluwalia said.

"I don't want to speculate on what the budget is going to say on the fiscal deficit. Clearly it will not be the FRBM level but I don't think we should worry about it."

The FRBM law seeks to rein in the fiscal deficit to 3 percent by 2008/09 and wipe out the revenue deficit but due to the slowdown the government has pressed the pause button for these targets.

On Tuesday the benchmark 10-year bond yield rose to 7.01 percent from Friday's close of 6.93 percent on fears of more borrowing. It has risen 176 basis points this year mainly after a record high government's market borrowing.

Ahluwalia said the worst was over for the economy. "We will now get back to more normal growth," he said, adding delayed rains may not have much impact on the economy.

The Indian economy expanded 6.7 percent in 2008/09, slowing sharply from 9 percent of previous year. The central bank expects growth to moderate further to 6 percent in 2009/10.