China and India are being bracketed as fastest growing economies, which make us feel proud, but India was singularly marked out for caution against the highest inflation it has had among emerging economies. Mr Mukherjee's expectations have, however, been derailed by the political difficulties of a scam-scarred government, and even more by macro-economic risks at home from possible over-heating of an economy operating a little above capacity and from global financial market volatility.

Peripheral economies in the Eurozone are still grappling with the sovereign debt crisis affecting the stability of euro which has been fluctuating in relation to the dollar. Consumer price inflation in Europe now exceeds the two per cent target due to rise in food and energy prices. Recovery is still fragile in the United States where unemployment at over 9 per cent remains unacceptably high and the Federal Reserve will persevere with its continually extended near zero interest rate regime and quantitative easing (purchase of 600 billion dollars of Treasury securities) till the first half of 2011.

Meanwhile, there have been signs of signs of investors becoming more risk-averse in emerging economies, barring China where inflation is being fought with determination by shift to 'prudent' monetary policy and revisions in key interest rate and reserve ratio. India's current twin deficits, fiscal and external, the elevated inflation and a perceived lack of a more conducive environment for enlarging profile, given the politically unsettling climate, has made foreign investors wary. The current account deficit has now exceeded the safe limit of 3 per cent of GDP while the fiscal deficit though being held within the targeted 5.5 per cent of GDP in 2010-11, will remain high in the coming year, taking the combined deficits of the Centre and States together.

In recent weeks, there has been some outflow from the rapid build-up in foreign portfolio investments in India during 2010 while there has been a relative decline in foreign direct investment (FDI) flows. A significant flow of external capital has helped to balance payments on external account over the year. Against a mix of adverse factors like variable inflation, political uncertainties and none-too-promising global trends, the Bombay stock market, a leader in Asian markets, has lost its shine and currently experiencing greater volatility. At one stage, the Finance Minister did try to inject morale into the market but of no avail.

IMF in its latest appraisal of the Indian economy said the elevated inflation required to be addressed by further monetary tightening to contain demand pressures by moving interest rates to positive territory, i.e. increasing them to bring real short-term rates in line with historical norms. IMF, however, noted that the task of the central bank has been made somewhat difficult by an expansive fiscal policy. In the context of the Finance Minister's concerns for growth, RBI did not go as far as IMF had envisaged for monetary tightening and, contrary to the widest expectation of an increase by 50 basis points, limited it to 25 basis points. Most analysts expect further hardening of interest rates for months to come.

In other words, the Finance Minister faces the prospect of having to compress expenditure in the coming year to some extent even as he would like to raise more resources for investments in physical infrastructure and social development sectors including flagship programmes in 2011-12, the terminal year of the 11th plan. It would be politically difficult for him to lower the level of food, fuel and fertiliser subsidies with elections due in several states over the next three months.

Nor political conditions are favourable for Mr Mukherjee to come up with some bold measures to change the economic climate, at a time when the BJP-led opposition having forced an abrupt adjournment of the winter session of Parliament, is still holding the Government in tight leash over its demand for a JPC probe into 2G spectrum scandal. This could affect any moves by Government to push through some of the pending policy reforms that foreign investors look for. Mr Mukherjee has been trying to bring round the opposition to cooperate for a smooth budget session by going more than half way to meet their demand.

IMF has called on India not only to cut down the high level of subsidies in order to be able to do more for both infrastructure and social programmes but also put through the needed reforms to attracting greater flows of foreign capital. Since the economy is already operating above its current potential, it has suggested withdrawal of whatever is left of the counter-cyclical measures taken during the global economic crisis. Let alone any stark reduction in subsidies, Government has ruled out for the present the deregulation of diesel prices which had been proposed last year.

Mr Mukherjee will have, however, to see that while he seeks to improve the total receipts of Government in the coming year, the budget does not add to the present price spiral He will be circumscribed in having recourse to any new levies beyond some correction of the earlier concessions extended during the global economic downturn. He may have some elbow room in operationalising the Direct Tax Code which is to come into force from April 2011. In the absence of raising any more one-off measures like the 3G spectrum revenues in 2010, it would be difficult to limit the Centre's fiscal deficit to the 4.8 per cent GDP as projected in the Medium-Term Fiscal Policy Statement.

The surge in international commodity prices — oil, food, metals and other commodities — is now posing threat to macro-economic stability of several emerging economies and developing countries. Global inflation is bound to cloud the outlook for the world economy in 2011. Brazil, which has been raising its interest rates, has also decided to cut the size of its budget to keep deficit within limits as anti-inflationary measure. The Finance Minister may have recourse to freezing the level of expenditure at current levels except for marginal additions for ongoing flagship programmes including the National Rural Employment Guarantee Programme which would now require additional outlay with the linking of wages to inflation. Mr Mukherjee may perhaps throw up some sops for foreign investors and facilitate an extension of banking in the private sector with some regulations. (IPA Service)