The government should relax the fiscal consolidation roadmap in the face of challenge posed by the 7th Pay Commission by budgeting for wider gap of 3.9 per cent for 2016-17, which will help push GDP growth, says a report.
"Relaxing the fiscal deficit (is the) key" because of the implementation of the pay panel's proposals which are likely to set a 0.7 per cent hole in the government finances, foreign brokerage Bank of America Merill Lynch said on Friday.
Finance Minister Arun Jaitley is slated to present the Budget for financial year 2016-17 next month.
"We expect the 0.7 per cent of GDP stimulus from the 7th Pay Commission to boost consumption from the second quarter of 2016. It's pre-condition that Jaitley relaxes the FY17 fiscal deficit target to 3.9 per cent of GDP same as FY16's from the pre-committed 3.5 per cent," it said.
Under a medium-term fiscal consolidation plan, the government is committed to get the fiscal deficit down to 3 per cent by 2017-18. It had already taken a relaxation for 2015-16 to support growth and under the revised plan, it has to achieve 3.5 per cent in 2016-17.
The fiscal deficit stokes inflation and also crowds out private investment, and hence, is a key number monitored by both the RBI as well as the international rating agencies.
BofAML sought to downplay the negative effects, saying the gap is "well below" the medium term average of 4.8 per cent since FY2000.
The stimulus received from the 7th Pay Commission, along with lending rate cuts and a rollover of foreign deposits taken in 2013, will help the GDP growth to accelerate to 7.7 per cent in FY17, it said. The government had last month cut its FY16 growth estimate to 7-7.5 per cent.
RBI Governor will not cut by more than 0.25 per cent at the upcoming policy review on February 2, the note said, adding that it expects another 0.50 per cent in cuts in April-September 2016 to support growth.
It said the fears of the government crowding out private sector are also "overdone", adding that it will have to increase borrowing by 13.6 per cent to Rs 5,530 billion in 2016-17.
There is "undue stress" on reforms for pushing growth, it said, adding that it supports GDP expansion over a longer 5-10 year period, whereas the current challenge is a cyclical recovery.