WHILE the first four years of the United Progressive Alliance (UPA) government in India was a dream-run, so far as the economy was concerned, the final year has been a nightmare.

Last week, Pranab Mukherjee, over-worked foreign minister (who is also the acting prime minister and finance minister, as Manmohan Singh is recuperating from surgery) presented the nation a grim report card of the economy.

The fiscal deficit for the current financial year (ending March 31) is estimated to rise to six per cent of gross domestic product (GDP), way above the original target of 2.5 per cent. The six per cent figure, also the highest recorded in 18 years, is not a true reflection of the deficit, as it does not include the shortfall of state governments and off-budget items like bonds issued to oil companies.

According to Mukherjee, the government initially expected the fiscal deficit for 2008-09 to be around 2.5 per cent; an additional half a per cent was added following the implementation of a pay commission, which saw over five million government employees get wage increases of more than 20 per cent.

However, by the time he presented an ‘interim budget’ – in effect a vote on account – last week, the fiscal deficit projection had ballooned to six per cent. The Fiscal Responsibility and Budget Management Act (FRBMA) stipulates that the fiscal deficit should not exceed three per cent.

The government’s borrowings are expected to top Rs2.6 trillion in the fiscal ending March 31, up from an original borrowings projection of a trillion rupees. Next financial year, beginning April, also provides no relief. Mukherjee estimates the fiscal deficit to decline marginally to 5.5 per cent, though government borrowings are expected to exceed Rs3.1 trillion.

“Conditions in the year ahead are not likely to be normal and, therefore, the high fiscal deficit is inevitable,” remarks Mukherjee. “We will return to FRBM targets once the economy is restored to its recent growth path. Extraordinary economic circumstances call for very extraordinary measures.”

Montek Singh Ahluwalia, deputy chairman, Planning Commission, estimates that the fiscal deficit would touch 7.8 per cent if off-budget items like bonds are included. The government issued bonds amounting to nearly a trillion rupees to oil and fertiliser companies, compensating them for the subsidised products that they sold.

But Duvvuri Subbarao, the governor of the Reserve Bank of India, the country’s central bank, estimates that the combined fiscal deficit of both the central and state governments could well touch the 10 per cent of GDP mark in the current fiscal. Analysts expect the combined fiscal deficit to add up to 12 per cent of GDP.

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THE Indian economy is expected to grow by an impressive 7.1 per cent in the current fiscal, though this is much below the 9 to 9.5 per cent growth rates achieved over the past four years. Foreign investments, tax revenues, international trade and the capital markets were buoyant for most of the four years of the UPA government.

However, political compulsions – when the government had to take the support of the Left parties – forced it to squander billions of rupees on populist schemes, allegedly meant for the benefit of the poor, but which have only been fattening contractors, politicians and unscrupulous elements within the bureaucracy.

Flush with cash during the good years, the government went about throwing money at populist schemes, not worrying about the consequences on its finances. Many of the schemes – including the National Rural Employment Guarantee Scheme, the Jawaharlal Nehru National Urban Renewal Mission and the farm loan waiver programme – had good intentions, but are being mismanaged by corrupt elements within the government.

The really poor are deprived of the benefits of the schemes, while a mafia comprising middle-men, contractors and corrupt administrators grabs a significant chunk of the money. Similarly, subsidies meant for the poor – on kerosene, diesel and fertiliser – are hogged by the affluent, resulting in a bloating fiscal deficit.

The global economic crisis is taking a huge toll on India as well. Foreign investors have pulled out funds, the stock markets have collapsed, exports have dried up and government revenues are also shrinking. Meanwhile, millions of jobs are being lost, especially in the export sector, adding up to the government’s worries in an election year.

General elections are due to be held before May along with assembly elections in several states. In fact, 2009 will be a busy election year, with many large states – including Maharashtra – facing elections.

But whichever party – or alliance, as is most likely – comes to power, it will have a difficult year or two, what with decelerating growth, a ballooning deficit and a snowballing economic crisis. With India, in recent years, being ruled by alliances led by a large national level party – the Congress or the Bharatiya Janata Party – and comprising smaller, regional parties, the new government that takes over in May will have limited scope for injecting a dose of bitter medicine.

And just as governments in the United States, China and other major economies are being forced to unveil stimulus package, the current dispensation too has been under pressure for similar sops. “Countries are announcing bailout packages and unless the developed countries manage a turnaround, achieving high growth rates will be difficult for emerging economies,” complains Mukherjee.

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THE flaring fiscal deficit has led to fears that international credit rating agencies might downgrade India’s standing, leading to drying up of funding sources and costlier loans. James McCormack, the head of Asia-Pacific sovereign ratings at Fitch Ratings, notes that the deficit could deter foreign capital, slowing India’s growth prospects.

“We consider the public finance position of India to be a serious ratings weakness,” points out McCormack. The ratings agency has given India a BBB- local currency rating, with a negative outlook.

Standard & Poor’s also rates the local currency rating at BBB-, the lowest in investment-grade ratings. It rates India’s overseas and domestic credit at the lowest, investment grade. Moody’s rates India’s currency at speculative grade.

Fiscal deficits are tolerated in times of crisis, when governments have to pump-prime the economy by injecting funds. However, India’s fiscal deficit shot up to unacceptable levels even before the government began tackling the economic crisis.

A widening fiscal deficit can lead to several complications, distorting the economy. For one, the government is forced to borrow heavily, leading to a squeeze on liquidity for productive purposes, especially for the private sector. Interest rates start rising, despite sluggish demand for goods and services.

Governments are also tempted to monetise the deficit, by printing more money, which then leads to soaring inflation.

The growing fiscal deficit will deter the next government from undertaking ambitious projects that India needs desperately. The Manmohan Singh government had identified $500 billion worth of infrastructure projects in sectors like power, ports and airports, roads and highways that must necessarily be taken up to boost the economy and pull millions of Indians above the poverty line.

Government spending on such crucial projects has been sluggish, leading to enormous shortages of electricity, congestion at ports and airports. With a spiraling fiscal deficit, the new government will not have the needed funds to invest in these projects, nor would it be able to raise the money needed to build infrastructure.

The UPA government was also hopeful that international investors would rush in and take up the projects on a public-private partnership basis. But the global financial meltdown has resulted in a liquidity crisis and foreign investors are now reluctant to take up projects, or even bid for them.