Two lessons can be drawn from that experience. First, that the expansionary stimulus from the state has to be sustained if the recovery is to continue. And, second, that a conscious effort must be made to reduce the share of interest payments in the "expenditure" of the government.
 
An expansionary stimulus, in the form of more public expenditure, can be financed in two ways : greater resource mobilisation through taxation and a higher fiscal deficit. The strategy of economic liberalisation, however, militates against the first. Not only are customs duties being reduced consistently as part of the import liberalisation, but a range of direct and indirect tax concessions have been provided over time resulting in a fall in the net tax-GDP ratio at the centre from 7.9 per cent in 1989-90 to 5.9 per cent in 1998-99 (Chart 2).
Chart 2 >>
 
The rise in oil prices and the slight buoyancy referred to earlier has helped raise this figure to 6.5 per cent in 1999-00. The feeble effort made in this budget to sustain this trend by raising the surcharge on income tax and bringing export incomes into the tax net has, as expected, been received adversely by those who see it as an unnecessary intrusion of the state into private activity.
 
The net result of the trends in taxation and expenditure has been that the fiscal deficit at the centre has proved stubbornly resistant to reduction, rising from 4.9 per cent per cent in 1996-97 to 7.0 per cent in 1999-2000. (These figures differ from those quoted by the government in the budget papers, since it is based on the older definition of the fiscal deficit which includes all the small savings accruing to the government a part of which is transferred to the states. However, Chart 3 provides three alternative estimates of fiscal deficit to GDP ratios: the official ratios themselves, the ratios computed using the government's figures of the fiscal deficit and the CSO's GDP estimates and ratios computed using the older definition of the fiscal deficit and the CSO's GDP estimates).
Chart 3 >>
 
But this rise in the fiscal deficit is not merely the result of past non-interest expenditures financed with 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. Till 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 ready access to credit to the government 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 RBI, this is partly true. Partly, 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 inflation 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-inflationary, but virtuous from the point of view of growth.