The Narendra Modi government should "relax" the fiscal deficit target in the wake of impending financial burden resulting from the implementation of Seventh Pay Commission recommendations, said a global brokerage firm.

The government should raise the fiscal target to 3.9% for 2016-17 against a current 3.5% set for the year, Bank of America Merill Lynch (BofA-ML) said in 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," the brokerage said.

Finance Minister Arun Jaitley will present the Budget for financial year 2016-17 in February.

"We expect the 0.7% 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% of GDP — same as FY16's — from the pre-committed 3.5%," Business Standard quoted the brokerage as saying.

Earlier this week, a report said the government was examining proposals to revise up the fiscal deficit targets in a bid to boost domestic demand.

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".

Raising deficit targets could severely undermine the efforts of the Reserve Bank of India (RBI) to check inflation.

However, BofA-ML said the deficit gap is "well below" the medium term average of 4.8% since FY2000.

The brokerage said stimulus from 7th Pay Commission, RBI rate cuts and a "rollover of foreign deposits" taken in 2013 will support the country's to post a gross domestic product (GDP) growth of 7.7% in the next fiscal year, it said.

It expects the RBI governor to cut rates by further 20bps at the policy meeting on 2 February.

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