But this rise in the fiscal deficit is not merely the result of past non-interest expenditures financed through debt, which have contributed to an increase in outlays on interest payments. It is also the result of the change in the manner in which government deficits have been financed in recent times as a result of financial reform. Until the early 1990s, a considerable part of the deficit on the government's budget was financed with borrowing from the central bank against ad hoc Treasury Bills issued by the government. The interest rate on such borrowing was, at around 4.6 per cent, much lower than the interest rate on borrowing from the open market. A crucial aspect of financial reform has been the reduction of such borrowing from the central bank to zero, resulting in a sharp rise in the average interest rate on government borrowing.
 
The shift away from borrowing from the central bank has been advocated on three grounds. First, that such borrowing (deficit financing) is inflationary. Second, that it undermines the role of monetary policy by depriving the central bank of any autonomy. And, third, that it undermines much needed fiscal discipline by providing the government with ready access to credit at a low rate of interest. We need to consider each of these in some detail. The notion that the budget deficit, defined in India as that part of the deficit which is financed by borrowing from the central bank, is more inflationary than a fiscal deficit financed with open market borrowing, stems from the idea that the latter amounts to a draft on the savings of the private sector, while the former merely creates more money.
 
In the current context where new government securities are ineligible for refinance from the Reserve Bank of India (RBI), this is partly true. This is in part because the need for refinance to create additional credit arises only when the banking system is stretched to the limits of its credit-creating capacity. If, on the other hand, as is true today, banks are flush with liquidity, government borrowing from the open market adds to the credit created by the system rather than displacing or crowding out the private sector from the market for credit. This too can be inflationary if supply-side bottlenecks exist. But even if government borrowing is not financed through a draft on private savings but through the printing of money, such borrowing is inflationary only if the system is at full employment or is characterised by supply bottlenecks in certain sectors.
 
As mentioned earlier, not only is the industrial sector burdened with excess capacity at present, but the government is burdened with excess foodstocks and foreign exchange reserves. This implies that there are no supply constraints to prevent "excess" spending from triggering output as opposed to price increases. Since inflation is already at an all-time low, this provides a strong basis for an expansionary fiscal stance, financed if necessary with borrowing from the central bank. To summarise, in the current context a monetised deficit is not only non-inflationa ry, but virtuous from the point of view of growth.
 
This brings us to the second objection to a monetised deficit, namely, that it undermines the autonomy of the central bank. This demand for autonomy, which is a central component of International Monetary Fund (IMF)-style financial reform, assumes that once relieved of the task of financing the government's deficit, the RBI would be in a far better position to control money supply and therefore "free" to use monetary policy as a device to control inflation, manage balance of payments, and influence growth. In practice, IMF-style financial reform has hardly enhanced the autonomy of the central bank, since it not merely involves curbing the Government's borrowing from the RBI, but also liberalising regulation of capital flows into and out of the country. Since such flows are extremely volatile, the central bank is constantly forced to adjust to these "autonomous" capital movements. In recent times, for example, portfolio inflows which went way above the $50 million a day mark increased foreign exchange availability in the market and threatened to raise the value of the rupee, even when the trade deficit was widening.
 
This has required the central bank to intervene in the foreign exchange market and purchase dollars in order to stabilise the rupee, resulting in a sharp increase in the foreign exchange reserves with the RBI. Since an increase in the central bank's foreign assets has as its corollary an increase in its liabilities in the form of the supply of money, monetary policy remains solely concerned with neutralising the effects of foreign capital inflows. Relieved of the dominance of fiscal over monetary policy, the RBI now finds itself straitjacketed by international finance.
 
Finally, the evidence cited earlier makes it clear that even putting an end to the practice of monetising the deficit has hardly had any effect on the fiscal situation. Fiscal deficits remain high, although they are now financed by high-interest, open-ma rket borrowing. The only result is that the interest burden of the government tends to shoot up, reducing its manoeuvrability with regard to capital and non-interest current expenditures. This effect of financial reform on the fiscal manoeuvrability of t he state can be assessed by comparing actual fiscal trends with a hypothetical situation where the government had continued financing the same share of its deficit (around 30 per cent) with central bank borrowing as it did in 1989-90. In that case, a simple simulation exercise reveals, the interest burden in the Budget would have risen from Rs.17,757 crores to only Rs.88,464 crores in 2000-2001 as compared with the estimate of Rs. 101,266 crores recorded in this year's Budget papers. Such a possibility of saving in interest payments of close to Rs.13,000 crores or 12.6 per cent in the terminal year is obviously the culmination of a rising gap between actual and hypothetical interest payments starting from the mid-1990s when the practice of monetising a part of the deficit was done away with. This cumulative saving would have implied a huge reduction in the size of the fiscal deficit, assuming that expenditures remained the same. Over the 1990s as a whole, the cumulative reduction in the deficit would have been more than Rs.100,000 crores, which is far more than what the government could possibly have mobilised through disinvestment.