The government needs to boost tax revenues and cut expenditure to rein in a burgeoning fiscal deficit and help cool inflation pressures and bolster longer term growth, the government said in a survey on Thursday, a day before the annual budget.
New Delhi is expected to miss this fiscal year's deficit target of 4.6 per cent of GDP by a wide margin, and it faces a difficult task to cut a soaring subsidy bill and revive slowing growth.
A yawning fiscal shortfall is not only making credit dearer for private investment, it is also foiling the central bank's efforts to control inflation.
The Reserve Bank of India left interest rates unchanged on Thursday, warning of resurgent inflation risks from surging crude oil prices, fiscal slippage and rupee depreciation.
"While an expanded deficit can boost consumption and economic growth, this is medicine akin to antibiotics. It is very effective if properly used and in limited doses, but can cause harm if used over a prolonged period," the economic survey by the finance ministry said.
It suggested an increase in tax rates to boost tax-to-GDP ratio to 13 per cent by 2016/17 from 10.5 per cent currently. It also favoured a cap on the fuel subsidy, which has already topped 536 billion rupees this year – more than double the target for 2011/12.
The recommendation comes at a time when Prime Minister Manmohan Singh's government is facing a political storm for raising railway passenger fares on Wednesday for the first time in eight years.
In a country where populist policies are often rewarded with electoral gains, any decision to tinker with subsidies and tax rates could test the Congress party-led ruling coalition's political nerve.
Finance Minister Pranab Mukherjee is widely expected to unveil measures to trim the fiscal gap when he presents the annual budget. But much will depend on the government's resolve to cut its subsidy bill.
The economic survey said a lower fiscal deficit will help investments to rebound quickly.
Economic growth faltered to a three-year low of 6.1 per cent in the December quarter following a contraction in investment, and the pace of economic expansion this fiscal year is forecast to dip below 7 per cent for the first time in three years.
Capital investment has dropped to 30 per cent of GDP in the fiscal year ending on March 31 from 32 per cent a year ago.
The economic survey, however, forecast a pick up in the economy in 2012/13 as it expects fiscal consolidation along with lower inflation will help investments recover.
It expects annual economic growth to be about 7.6 per cent in 2012/13 and 8.6 per cent in the year after.