Should thighs touch the stomach to reduce flab? I got myself a new bike and i have been told by many to reduce the seat height or bend more to cycle such that the thighs touch your stomach or atleast closer to stomach as you cycle. They say it will reduce the flab quickly and better workout. 

Is this true?
I think that this is a bad advice you've heard (by many?).

For pedaling seated, the seat has only one position; the proper one. See How do I determine the correct position for my bicycle seat? for info on how to set it correctly.

Regarding the flab thing, as far as I know touching your stomach with your thighs (or any other part of your body) will not contribute to a better workout or a six pack. For that I guess you'll need lots of proper training and a consistently proper diet.