The Indian economy expanded by 6.8% in FY09, a year when economic activity across the world was hit by the aftermath of the Western financial crisis. The government said on Tuesday that it expects the Indian economy to grow at 6.9% in the current fiscal year, which is almost three percentage points lower than the peak of 9.6% hit during the previous economic boom. And this initial estimate could be brought down later given the metronomic regularity with which growth estimates have been downgraded in recent months. In other words, this fiscal year threatens to be the worst in nearly a decade.

All eyes will now be on the forthcoming Union budget. The government has very little fiscal space to support aggregate demand. The Reserve Bank of India has slightly more room to cut interest rate, but the central bank has quite correctly pointed out that its ability to stimulate the economy is linked to credible fiscal correction. What finance minister Pranab Mukherjee does in his next budget will thus determine the course of the Indian economy over the next two to three years, especially since the budget after this one may be made in the shadow of an early Lok Sabha election.

Both the International Monetary Fund and the World Bank have warned in recent assessments of the world economy that governments in Asia may need to keep some powder dry in case there is a major shock emanating from Europe. The United Progressive Alliance has used up all its firepower in good times. It cannot provide a fiscal stimulus without carrying significant risk of a sovereign debt downgrade by international credit rating agencies. What it can do is realize that there is not enough room for fiscal stimulus but try harder to provide a reforms stimulus. Of course, that is easier said than done given its record in recent years.

• • •

Also Read | Govt pegs 2011-12 economic growth at 6.9%