The Narendra Modi government is reportedly examining proposals to revise up the fiscal deficit targets in a bid to boost domestic demand, even as it claims India as the world's fastest-growing economy.
Such a move could severely undermine the efforts of the Reserve Bank of India (RBI) to check the inflation.
Despite the above-7% growth recorded so far in the current fiscal, economic advisors to Prime Minister Narendra Modi have expressed doubt over slowdown hitting the "budget calculations".
Finance Minister Arun Jaitley, who will present the budget for 2016-17 in February, has been advised to raise the fiscal deficit target to 3.7% or 3.9% of the gross domestic product (GDP) from the 3.5% aimed earlier, a senior official told Reuters.
A proposal to postpone the target of achieving 3% fiscal deficit in 2017-18 by a year is also under consideration.
"The economy is still suffering from slack demand," said the Finance Ministry official. "It needs a conducive fiscal and monetary policy."
However, the government is yet to finalise increasing the fiscal deficit targets, said Shaktikanta Das, the ministry's Economic Affairs Secretary.
A higher deficit could make it difficult for the RBI to reach inflation target of 5% by March 2017.
"A miss on the fiscal targets will narrow scope for additional rate cuts," said economists at DBS in Singapore.
A sharp contrast between nominal and real rates of growth and the "direction" of wholesale and retail inflation rates has given rise to differences on whether the government should increase spending and face high inflation or reduce fiscal deficit to keep it under control.
"GDP data is underestimating nominal growth and overestimating real growth," said N R Bhanumurthy, a professor at the government-funded National Institute of Public Finance and Policy.
While a decline in wholesale prices calls for a stimulus, a recent spike in retail inflation, which has renewed worries over price rise, argues for a reduction in fiscal deficit.
"We know the economy is recovering," the Finance Ministry official said. "But no one is sure about the recovery's pace and strength."
The RBI is already preparing to counter the impact on inflation following the implementation of salary hikes recommended by the Seventh Pay Commission for government employees.
"The mess is being created in Delhi, but the RBI will have to absorb the shock," said Bhanumurthy.
