The economic conditions under which this interim budget is being presented are very different from those during previous election period transitions. The signals of the impending slowdown of the economic activity and rising unemployment need a more proactive approach, rather than the autopilot mode that interim budgets are supposed to represent.

Whatever the outcome of the elections, the new executive is not likely to be operational before June. It is precisely this intervening period between now and June that is will be crucial for arresting the ongoing slowdown, stabilising the economy and getting it back on a growth track. If government responses are allowed to drift, the repercussions on domestic demand will be diffused, bank credit will not rise in any meaningful sense, the monetary base will increase and conditions for a rapid increase in inflationary pressures are likely to build up.

What are the targets that the stimulus package must address? The dominant drivers of the current slowdown are, first, a global trade slowdown in both goods and services and second, a constriction of credit for investment and consumption, driven both by reduced access to global funds and concerns of banks and investors on credit quality. What started in early 2008 as an investment led slowdown has swiftly spread to consumption after September.

Except for China, it is unlikely that any of the other major developed economy geographies will recover anytime in 2009. The competition for China?s markets will be intense and gains for India of a modest recovery are likely to be small. So we need to find ways of diverting external demand back towards India consumers and corporations. At the same time, credit flows need to be channeled towards selected sectors, and it is unlikely that there will be any significant increase in global capital flows in the near future. These are the restraints that a stimulus programme will have to operate within.

The scale and nature of the stimulus measures needed for this process requires a significant coordination between monetary and fiscal policies, with a careful calibration of fiscal responses to the slowdown. A significant fiscal stimulus will, as we have seen, weaken, if not negate, the impact of monetary policy easing. The RBI has responded in its monetary policy stance in the best possible manner, given the sharply increased deficit of the centre and the consequent borrowing requirements.

While we do not expect that the fiscal hit will be as bad in 2009, it will still be substantial. The centre?s deficit is likely to be about 4.5% of GDP. This will prevent yields on government paper in the medium to long tenors from dropping too much. This is a major impediment for monetary policy formulation. What are the best ways for the fiscal and monetary policy legs to act under these circumstances? What combination of fiscal and monetary policy might be most effective?

One leg of the stimulus is focused on increasing consumption demand. The most effective means of doing this is through tax cuts, both direct and indirect. This will remain the primary component of the fiscal package, complemented by income generation programmes like the NREGA.

The other component of the stimulus ? investment ? can be infrastructure driven. India needs better infrastructure anyway. The problem is the persistent high interest rates. For monetary policy, one component of persistent, high interest rates is the perception of elevated credit risk. Some form of sovereign support if likely to provide comfort to lenders. Therefore, rather than directly raising resources for state expenditure, it might be better for the government to facilitate private investment through guarantees. The government can leverage its (much smaller) borrowed funds to facilitate private sector resource raising. Done sensibly, this will infuse stricter commercial orientation in infrastructure projects, and probably greater market discipline. Of course, this sovereign backstop increases moral hazard in the projects, but stringent sharing of risks between lenders and project developers with the government will mitigate some of these effects.

The biggest implication of this approach will be the more limited market borrowings of the government, which will alleviate the pressure on the longer maturities of the sovereign yield curve and thereby achieve the objectives of lowering benchmark sovereign interest rates, thereby passing on signals to bank lending and deposit rates.

?(The views are the author?s own and do not necessarily reflect those of the institution to which he is affiliated)