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Doctor's Dilemma

To borrow more or not: that is the question before the government. There is a distinct possibility that the Centre would end up borrowing more than what it has budgeted for, but that could in turn provide a further fillip to inflation

Inflation is undoubtedly the biggest economic problem before the Centre at present. The next big constraint has been the uncertain monsoon--there was deficient rainfall in 13 out of the 36 meteorological subdivisions in the country. Consequently, the anticipated 3 per cent increase in agricultural output is not going to materialise this fiscal year. Unfortunately for the government, it has absolutely no control over the factors that have been responsible for high international prices of crude oil and erratic precipitation.

What the government does have control over is the quantum it borrows, in other words the extra amount of money that is pumped into the system through borrowings undertaken by the Union government through the Reserve Bank of India. In this area as well, the UPA government headed by Dr Manmohan Singh is in the horns of a dilemma. The government is under tremendous pressure to borrow more to fund ambitious welfare programmes. At the same time, it is aware of the fact that more liquidity in the economy could lead to the phenomenon of more money chasing relatively few goods. This, in turn, could lead to higher prices at a time when the inflation rate is already at an uncomfortably high level, largely on account of increase in the prices of petroleum products.

The mid-term review of the annual credit policy announced by the RBI Governor Dr Y.V. Reddy on October 26 did not tinker with the interest rate structure but made a number of references to the difficulties that lie ahead. The RBI stated that the annual rate of inflation--measured point-to-point by the official wholesale price index--would rise sharply from a level of 5 per cent projected in May to 6.5 per cent at the end of March 2005. Even this is a rather optimistic prognostication.

The RBI has pointed out that till October 21, the Centre had completed nearly 50 per cent of its gross market borrowings and almost 30 per cent of its net borrowings for the full financial year. "The market borrowing programme in the remaining part of the year needs to be calibrated carefully in view of strong credit demand," Dr Reddy observed. This is a polite way of saying that if the government borrows more than what it intends, it could lead to a "crowding out" phenomenon which, in turn, could lead to an upward pressure on interest rates.

The government and corporate captains have the greatest stake in the "soft" interest rate regime continuing. The government, after all, is the biggest borrower and wants low interest rates so that it can keep its revenue deficit low to meet the stringent terms and conditions of the Fiscal Responsibility and Budget Management Act. Although interest rates are at their lowest in thirty years in nominal terms, in real terms, given the recent rise in inflation, interest rates are actually negative. Whether and how soon negative real interest rates would reduce the rates of savings and investment, remains to be seen.

There is a distinct possibility that the government will end up borrowing much more than what it has budgeted for. There is pressure not merely from the Left parties but also from Sonia Gandhi herself to embark on an ambitious employment guarantee scheme that intends providing 100 days of gainful work (at the minimum wages) to one able-bodied member of each family in the country as has been promised in the national common minimum programme of the UPA coalition. Such a scheme is certain to require large sums of money, which can come only from fresh borrowings.

More borrowings, in turn, could provide a further fillip to inflation, which--even the most ignorant home-maker will tell you--hurts the poor and makes the government unpopular. This is the dilemma being faced by India's first PM who is an eminent economist.

(The author is Director, School of Convergence and a journalist with over 25 years of experience in various media-print, Internet, radio and television)