(Adds background on twin deficits)
By Neha Dasgupta
CHENNAI, Oct 3 (Reuters) - India's government must tackle subsidies to restore fiscal discipline, Reserve Bank of India deputy governor Subir Gokarn said on Wednesday, highlighting tensions between the country's policymakers amid fears that it could suffer a credit rating downgrade.
"We need to address the fiscal situation and we need to address it fully, recognising that not dealing with subsidies is going to provide us very imperfect incomplete solutions," Gokarn told reporters on the sidelines of an industry event in the southern city of Chennai on Wednesday.
"Whatever else we may think of in terms of dealing with the fiscal situation, tackling the subsidy bill is going to be a central part of the strategy."
A government panel warned on Friday that India is on the edge of a "fiscal precipice" and should urgently slash fuel, food and fertilizer subsidies to curb a budget deficit that could hit 6.1 percent of gross domestic product this fiscal year.
India is targeting a fiscal deficit of 5.1 percent of GDP for the year 2012/13 ending in March.
The proposed subsidy cuts, if implemented, would likely spark a massive political backlash and put the ruling Congress party's re-election bid in 2014 in doubt.
Struggling to control stubbornly high inflation, the RBI has refrained from cutting its key policy repo rate after bringing it down by 50 basis points in April, even though economic growth in the June quarter slowed to a three-year low at 5.5 percent.
The central bank has maintained that further policy actions will be contingent upon government steps to reduce the twin fiscal and current account deficits, and cut spending.
India's current account fell 24 percent to $16.55 billion in April-June from the previous quarter, but Gokarn said it was still out of the central bank's comfort zone.
"We have some relief it appears from the first quarter (April-June) numbers, which take it (the current account deficit) to 3.9 percent of GDP, so that may be the beginning of some stabilisation there. But even that number is something that is outside what we have seen as a traditional comfort zone of 3 percent."
India' inflation has persistently stayed much above the central bank's comfort zone of around 5 percent and is still higher than its projection of 7 percent by end-March 2013, mainly due to high food prices.
The wholesale price index rose a higher-than-expected 7.55 percent in August from a year ago and a recent increase in diesel prices by the government to contain a large fiscal deficit may further push prices upwards in September and October.
"We see something like 6 percent as a level beyond which it becomes difficult to contain (inflation) because everybody starts to build this number into their expectations, price formation, wage formation, all of these drivers of inflation tend to start becoming more and more influenced by a high inflation number," Gokarn said.
The RBI will revise the inflation projection at its Oct 30 policy review, he added.
However, Gokarn declined to specify whether the October policy decision would be influenced by a series of reforms unveiled by the government in mid-September to revive sluggish economic growth.
"The policy changes that have happened over the last few weeks are very welcome in terms of addressing some of those risks, but eventually the judgment will have to be the how these actions influence the growth-inflation trajectory. And admittedly that balance is what our decision is going to be based on."
(Additional reporting by Shamik Paul; Writing by Suvashree Dey Choudhury; Editing by Kim Coghill)
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Keywords: INDIA CBANK/DEPUTY