The government pledged to nearly halve its fiscal deficit by March 2017 in a bid to avoid a credit rating downgrade and persuade the RBI to cut interest rates to help the ailing economy, but offered few concrete steps to meet the ambitious target.
The fiscal consolidation plan announced on Monday did not say how New Delhi aims to rein in a ballooning subsidy bill that has strained public finances and put the country's investment grade credit rating in peril.
Higher spending on fuel, food and fertilizer subsidies along with sluggish tax revenues has raised fears in some quarters that the fiscal deficit for the year to end-March 2013 could be as high as 6 percent of GDP.
A burgeoning deficit is undermining the Reserve Bank of India's (RBI) efforts to control demand-driven price pressures. The government's use of domestic savings to finance the deficit is crowding out private investment and growth prospects.
"We do not have an option," Finance Minister P. Chidambaram said at a news conference in New Delhi as he unveiled what he called a new fiscal consolidation plan.
New Delhi is aiming to keep the deficit at 5.3 percent of GDP this fiscal year, Chidambaram said on Monday in a revision to a previous target of 5.1 percent. He said they would reduce it further to 3 percent by the fiscal year 2016/17, from 5.8 percent at the end of the last fiscal year.
Under the plan, the government will focus on economising existing expenditure, reducing wastage, and increasing revenue from share sales in state-run companies, he said.
But financial markets were disappointed by the lack of specifics.
"In our view, the measures announced will be insufficient to contain the fiscal deficit at 5.3 percent of GDP in FY13 due to higher subsidies and lower tax revenues," Nomura said in a statement.
"I think part of my job is to tell the truth as I see it. I think 5.1 percent is challenging, 5.3 percent is doable, so we intend to work hard and achieve 5.3 percent," Chidambaram said.
A government panel said last month India was teetering on a "fiscal precipice" and called on the government to slash its subsidy bill in order to get the deficit under control.
But cutting the subsidies could be politically perilous for the populist ruling Congress party ahead of state and federal elections, and Chidambaram stressed that all programs to help India's poor would be protected under the consolidation plan.
"It is a tall order," said A. Prasanna, economist at ICICI Securities in Mumbai, referring to the 3 percent deficit target. "I would emphasise that there has to be some plan to cap subsidies."
Chidambaram's comments came a day ahead of the RBI's quarterly policy review. The central bank, which is not expected to cut rates on Tuesday, has previously called for fiscal consolidation measures from the government.
The central bank's governor, Duvvuri Subbarao, met Chidambaram on Friday. Chidambaram's announcement of a plan to reduce the fiscal deficit is unlikely to influence the RBI's policy stance, analysts said.
"The timing of these announcements (one day ahead of the RBI policy meeting) also suggests growing political pressure on the RBI to cut rates tomorrow," Nomura said.
Over the past six weeks, the government has increased the price of heavily subsidised diesel, opened up the retail sector to global supermarket chains, allowed foreign airlines to buy stakes in local carriers and proposed raising the bar on foreign direct investment in insurance firms.
Chidambaram, who moved into his post in August and embarked on a reform agenda almost immediately, has predicted a return to average GDP growth of about 8 percent over the next five years.
Analysts say government's finances and capital investment need to improve before the economy again hits the 9 percent growth it was clocking before the 2008 global financial crisis.
The International Monetary Fund sharply cut its economic growth forecast for India for 2012 this month to 4.9 percent from 6.1 percent previously. Rating agency Standard & Poor's said this month the country faces a one-in-three chance of a credit rating downgrade to junk over the next two years.