Shed the pretence

It should now be clear to most observers that India is not achieving fiscal correction. The revenue deficit budgeted for next year happens to be exactly the same (2.7 per cent of GDP) as it was a decade ago. If the fiscal deficit is seen to be lower, part of the drop is on account of definitional changes and is therefore an optical illusion.

For the rest, whatever correction has taken place is explained by the squeeze on transfers to state governments""whose own deficit has gone up as a consequence. The combined deficit of the central and state governments remains therefore in the vicinity of 10 per cent of GDP.

More importantly, the nature of the Common Minimum Programme, which drives this government (some of the driving is being done by the Left, the rest by Sonia Gandhi's National Advisory Council), is such that it calls for a steady increase in government spending""whether on the employment guarantee programme, investment in the public sector, or a variety of social welfare initiatives.

Equally, there is now little hope of the subsidy bill being trimmed because the Left will not hear of it. And the cushion provided in the last couple of years by falling interest rates will disappear once the government's average cost of borrowing bottoms out.

In short, if the hope was that the high deficits would be reduced by slashing expenditure, that hope has been dashed; the government is getting ready to spend more, not less.

If the deficit is to be corrected, therefore, the answer has to lie in raising the tax-GDP ratio. This has been happening, climbing from a trough of 8.3 per cent earlier this decade to a budgeted 10.5 per cent next year.

But this has not been enough to correct the deficit; much more is needed and there is no quick fix available.

Rather than pretend each year that fiscal correction is being achieved, it would be better for the country to recognise reality and reconcile itself to high deficits for the time being.

Some attention must be focused therefore on the macro-economic dangers of continuing to run a 10 per cent fiscal deficit (among the highest in the world). There is no immediate danger of either inflation or a foreign exchange crisis""partly because the booming software exports have solved India's current account problem.

And since capital continues to flow in, there is no liquidity crunch, which would otherwise have been the result of excessive borrowing by the government. In other words, interest rates will not go out of line.

Indeed, if GDP is growing faster than 13 per cent annually (in nominal terms), a 10 per cent deficit could even mean reducing the debt-GDP ratio over time! This analysis leads to the conclusion that today's level of deficits can be sustained for some time without serious macro-economic risk.

The problem would be if an admission of medium-term failure leads to long-term abdication on the issue. The way to prevent that is to change the fiscal responsibility law and put a more realistic time-table, with no escape clauses of the kind that exist now.