The biggest challenge before Finance Minister Pranab Mukherjee will be how to prevent a fiscal crisis. Economic reforms, good governance, labour reforms and financial sector liberalisation are policies where business as usual may not be ideal, but it is possible to do nothing and go on as usual. On managing the fiscal situation business as usual could result in a fiscal crisis, a loss of confidence in the Indian government, capital flight and a sharp depreciation of the rupee. With the debt to GDP ratio at 80 per cent, with no credible framework for fiscal consolidation, with the Fiscal Responsibility and Budgetary Management Act in tatters, the fisc is today in a very precarious position. Mukherjee has become finance minister when the world economy is in the worst recession since Indian independence, when domestic industrial production is falling, when exports are declining and when the RBI seems to believe there is no need for a monetary stimulus. But even if he were to provide no further stimulus, stabilising the debt-to-GDP ratio is not going to be easy.

So far, over the last one year, India has been very fortunate. The US and the UK have the privilege of running high deficits and rising debt-to-GDP ratios and still retaining the confidence of the international community. India is a developing country and the rate of expansion of the deficit would have scared anyone. However, thanks perhaps to the long-run India growth story, there has been no serious loss of confidence in India. As an emerging economy, however, we cannot take this confidence for granted. It has often been observed that a turn in confidence can be very sudden. At some point international debtors, as well as citizens, can lose faith in a government’s ability to repay its debt. International experience shows that the probability of default rarely rises slowly, it sees sudden jumps. India’s experience of 1991-92 was similar. When confidence dropped, India was thrown into a crisis.

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