RBI keeps up hawkish tone, says fiscal gap key

Duvvuri Subbarao, governor of the Reserve Bank of India, speaks during ''The Citi Series on Asian Business Leaders'' at the Asia Society in New York, August 29, 2012.

PUDUCHERRY (Reuters) - The Reserve Bank of India (RBI) Governor Duvvuri Subbarao said on Thursday inflation had to be brought down further, signalling the bank would stick to a hawkish stance, and the size of the fiscal deficit would be a key factor in determining monetary policy.

The RBI has kept its key policy repo rate unchanged since April because of inflationary pressure and widening fiscal and current account deficits.

Many economists expect the rate to remain unchanged at an October 30 policy review.

"We must recognise, it was above 10 percent, it has come down from double-digit level to what is now at 7.5 pct. So first, we have to acknowledge that inflation has come down, we need to bring it down further," Subbarao said.

"The number of things that are necessary for inflation to come down, we will take into account, as we go into our October 30 policy," Subbarao said after a central bank board meeting.

On Wednesday, RBI Deputy Governor Subir Gokarn, who heads the monetary policy department, also sounded tough on fiscal prudence, saying the government had to cut subsidies.

Last month, Finance Minister P. Chidambaram unveiled a series of steps to bring in reforms in the retail and aviation sectors and also raised diesel prices as concern over a sovereign downgrade threat loomed.

Armed with those measures to improve investor sentiment, Chidambaram has stepped up pressure on the central bank to cut rates, but analysts consider the reform measures as too small to soften the central bank's anti-inflationary stance.

A high fiscal deficit due to increased government spending eats into private investment and pushes up inflation.

New Delhi aims to contain the fiscal deficit at 5.1 percent of gross domestic product for the 2012/13 fiscal year that ends in March, but industry watchers are apprehensive there will be further fiscal slippage.

The fiscal deficit in the April-August period touched 65.7 percent of the full year target.

"Unless government binds itself to lower fiscal deficit targets, it will be difficult to make a case that the recent steps will lead to fiscal consolidation," said A. Prasanna, economist at ICICI Securities Primary Dealership.

"For RBI to cut rates, it needs both the conditions to be satisfied - falling inflation and a credible roadmap for fiscal consolidation," Prasanna said.

India's inflation has remained sticky and well above the central bank's March-end target of 7 percent, and is expected to rise further till December due to the recent fuel price increases.

India's wholesale price index rose a higher-than-expected 7.55 percent in August from a year earlier, mainly driven by higher food prices.

(Writing by Shamik Paul)