5. Introduce a credible fiscal policy: a medium-term strategy

India's gross fiscal deficit remains one of the highest in the world. The overall government deficit stood at just under 6% in fiscal year 2008. In fiscal year 2009, this may accelerate to above 7%, due to a large debt-waiver for farmers, a big wage hike for civil servants, increasing fertiliser and oil subsidies, and higher exemptions on income tax.

At such high levels, government borrowing crowds out private-sector credit, keeps interest rates high, adds to already high government debt, and becomes a key source of macro vulnerability.

A medium-term strategy for fiscal policy, which reduces the overall deficit to a sustainable level, is a must. Such a fiscal plan would provide several important benefits:

• It would discipline the government and politicians, restrain populist spending, improve governance and make the fiscal deficit largely independent of political and election cycles.
• It would allow the central bank the space to follow meaningfully an independent monetary policy, as it would be unburdened from providing large amounts of financing to the government, and focus on an inflation target, which fundamentally affects the lives of hundreds of millions of Indians.
• It would improve the overall savings rate by reducing government dissaving; improve sovereign ratings and the investment climate; and allow for increased credit to the more dynamic private sector, thereby increasing growth.
• The hard budget constraint that a fiscal rule would impose would discipline spending, and improve the composition towards more efficient and growth-enhancing purposes, such as towards health, education, and infrastructure.
• It would enhance macro stability, by increasing the flexibility of the government to respond to adverse shocks by tightening or loosening as the case may be. Currently, with such a high fiscal deficit, the government has no fiscal space to respond to high oil and commodity prices, without endangering its fiscal health, and a large increase in debt.

The basis of such a programme, however, has to be commitment by all political parties to improve the health of the government. It would require putting all off-budget subsidies on-budget so that citizens and Parliament can assess the true picture.