The point is that given the tendency to profligacy of governments in India, it is simply not credible to expect we can have a policy mix that will deliver a strong, or rather a stable rupee. The only policy that can exist hand in hand with the spending programme of the government, and a strong rupee, is a tight monetary policy regime. This implies high interest rates which, as we have seen, will not be tolerated by any political party with an interest in canvassing the support of industry. Given this policy mix, a depreciating rupee is an outcome we should expect.

Look for example, at the reaction from the finance ministry to the recent slide in the rupee's value. According to recent news reports, North Block is not in favour of interest hike any more. Instead, it wants the RBI to run down its reserves to protect the rupee. One part of the reason for this preference has to be that such a hike would hurt the government more than anyone else in the market. It borrows roughly $2.2 billion from the market every month. It will borrow another $17 billion by the end of this fiscal year. Even a hike of another 50 basis points would cost it another $ 85 million in interest on the new borrowing alone.

And this does not take into account the borrowings of state governments. All told, the Centre and the state governments (including their undertakings) between them will borrow somewhere between 9.5 and 11 per cent of our GDP this year, depending on how you calculate it. The borrowings of state governments are becoming more relevant to such calculations for a number of reasons.

For one, the states deficit has been rising over the last decade, with the revenue deficit now nearly five times what was it at the start of the 1990's. The combined public debt of the states is expected to reach slightly over 20% of GDP. This obviously means that private borrowings are crowded out of the market as the quantum of government guaranteed borrowing increases.

The proportion of the states debt that is raised from the market has also been increasing over the last decade, where previously most of these borrowings were in the form of loans from the Union Government and from financial institutions (FIs). This deficit is expected to grow further as the states begin to try to match Central government wages for its employees. As the quantum of state government borrowing increase, their debt service obligations also increase.

The government's commitment to reduce this deficit lacks credibility. It has not been able to resist pressure from the agricultural lobbies to retain subsidies. Privatisation has dragged for years in the face of pressure from labour unions and from government ministries. At the state level, governments have persisted in giving away power, leaving gaping holes in the finances of state electricity boards. The revenue deficit has burgeoned as a result.

It is in this context we have to look at the fiscal deficit, exchange rate linkage. The government did try to reduce rates by the sheer force of its authority. But in today's market economy, the government is often no match for the market equilibrium. The government-indced fall in rates led to a consumer demand boom, which also coincided, with a global demand for IT stocks. This is turn led to an increase in the demand for funds. The government could either reduce its borrowing programme, or monetise the deficit. It could also, on the other hand raise rates, but risk cutting short the incipient industrial recovery.

Monetisation seems to have been the route taken by the government. Net RBI advances to the Centre so far is around Rs 21,000 crore, which is twice the level it was at last year. At the same time, the Federal Reserve raised rates in the US economy repeatedly, in an effort to slow down the US economy. As the real interest gap between the US and the Indian economies narrowed, the rupee had to suffer.

The RBI now has the same three options on hand. It could monetise the deficit, and therefor settle for a weaker rupee, it could hope for a drastic reduction in the government's deficit (perhaps through a few big privatisations) or it could raise interest rates in the Indian economy. If you look at it, none of these decisions really rests with Bimal Jalan.