THE United Progre-ssive Alliance (UPA), which under the pressure of its former supporters, the four Left parties, launched several social welfare programmes, allegedly for the benefit of the poor, and wrote off farm loans, is now having to face the music of high fiscal deficits and raging inflation.

The overall fiscal deficit in the current fiscal is expected to surge to 7.5 per cent of the gross domestic product (GDP), as against the projected 2.5 per cent in the budget This increase is attributed to off-budget liabilities – including hefty subsidies on food, fertiliser and fuel – that keep piling on.

Last week, the Prime Minister’s Economic Advisory Council (EAC) came out with a grim warning: “The progress in fiscal consolidation shows that both the central and state governments are likely to overreach the fiscal deficit target while the persisting revenue deficit would remain a matter of concern.”

The growing off-budget liabilities could trigger off serious fiscal risks, said the EAC. It urged the government to urgently increase fuel prices as there is a large backlog of fuel price adjustments to be done. But with elections to nearly half a dozen states round the corner and general elections to be held early next year, the EAC’s sane advice is unlikely to be accepted by the government.

C. Rangarajan, a former governor of the Reserve Bank of India – the country’s central bank – who quit as chairman of the EAC last week (he will be entering the Indian Parliament as a member of the upper house), was concerned over the large outgoings for the UPA government’s pet scheme, the National Rural Employment Guarantee Scheme.

“Implementation of the Rural Employment Guarantee programme and the Sixth Pay Commission’s report, we think, will take the total deficit to five per cent,” remarks Rangarajan. “This is a very large fiscal deficit.”

Similarly, it painted a gloomy scenario on the balance of payments front, pointing out that the current account deficit will balloon to $41.5 billion, or 3.2 per cent of the GDP, up from 1.5 per cent in the fiscal 2007-08. This will be the first time that India’s current account deficit will touch such high levels since the 1991 economic crisis, which triggered off the reforms process.

However, according to Rangarajan though the current account deficit will exceed the pre-1991 levels (when it was 3.1 per cent of the GDP), the country is unlikely to face any crisis on the foreign exchange front, as its reserves were well over $300 billion at present. In 1991, India did not have adequate foreign exchange reserves to even pay for a week’s imports. Reserves had dipped precipitously to a billion dollars and the government had to pledge gold to the Bank of England. Inflation was around 17 per cent.

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THE EAC has projected a much slower pace of growth for the current fiscal. The economy is expected to expand by 7.7 per cent, down from last year’s 9.1 per cent, and lower than the earlier projections made by the government and the RBI of around 8 to 8.5 per cent.

The council has blamed the slowdown on external factors as well, including the global economic deceleration, tightening credit, falling equity markets and the regressive effects of commodity price-led inflation.

“But considering the magnitude of the adverse economic developments in 2008, the projected drop from nine per cent last year to 7.7 per cent this year is, in fact, modest,” says the EAC. The agriculture sector is expected to decelerate to two per cent (from last year’s 4.5 per cent), the industrial sector is expected to grow at less than 7.5 per cent (as against 8.5 per cent in the previous fiscal), and the services sector is likely to expand at 9.6 per cent (10.8 per cent in 2007-08).

Suresh Tendulkar, the new chairman of the council, however, feels that 7.7 per cent economic growth rate is not ‘unrespectable’ and would be the second highest growth rate in the global economy.

Finance Minister P. Chidambaram, however, believes that the Prime Minister’s EAC has been conservative in its projections and expects GDP to top eight per cent in the current fiscal. Other economists and industry associations also believe that the GDP will grow at between eight and 8.5 per cent in the current fiscal, especially as the south-west monsoon has been good.

But Rangarajan warned that high commodity, food and fuel prices would continue pushing inflation northwards. It could touch 13 per cent over the next few weeks, and may start declining only in December, he says. The RBI had last month said that it was targeting an inflation rate of seven per cent by March.

The outgoing chairman of the EAC feels that “a tight monetary policy needs to be maintained in the short run to ensure price stability. However, if inflation rate slows down, then further tightening may not be needed.”

Inflation, as measured by the wholesale price index, soared again touching a 16-year high of 12.44 per cent for the week ended August 2 (it was 4.39 per cent in the same week last year). According to figures released by the government last week, inflation touched a new high on the back of rising food and fuel prices.

Analysts expect the RBI to go in for another round of hike in its short-term lending rate (the repo) and in the cash reserve ratio. It could range from 25 to 50 basis points. Last month, the central bank had raised the repo rate by 50 basis points and the cash reserve ratio by 25 basis points.

WHILE the news was gloomy on the economic front, the government was in a generous mood last week, when it offered a huge hike in salaries to its five million employees, even besting the recommendations of the Sixth Pay Commission.

While the commission had suggested a hike of Rs300 billion, the government increased it to Rs410 billion. The 21 per cent hike in salaries would cost the government Rs177.98 billion a year, besides payment of arrears of Rs293.73 billion.

The minimum salary for a central government employee has now gone up to over Rs10,000 a month (including Rs7,000 as basic and another Rs3,000 in allowances). But this is way above the minimum salary level specified by the government.

Hundreds of thousands of state government employees are now expected to clamour for a pay hike, which could add to the burdens of the exchequer and also widen the overall fiscal deficit. Finance minister Chidambaram asserts that the projected budget deficit targets for the current fiscal will be met as the new pay scales have already been factored in the budget.

The government appoints a pay commission for its employees once every 10 years. The last commission’s recommendations had led to a huge spurt in wages for central and state government employees, upsetting the budgets of many state governments. It also aggravated the overall fiscal deficit, widening it by 1.5 per cent of the GDP.

The UPA government had set up a committee to go into the recommendations of the Sixth Pay Commission, after it received a lot of complaints from the Defence forces about the relatively low entry-level salaries.

Salaries in the Indian private sector – especially fast growing sectors like information technology/ITES, telecommunications, banking and financial services, civil aviation, healthcare, media and entertainment, infrastructure and real estate development – have been climbing steeply in recent years.