There were no gasps of surprise when Palaniappan Chidambaram, Indian finance minister, unveiled a populist budget aimed at boosting the chances of the Congress-led governing alliance in the general election due by May 2009.

Even so, the details announced on Friday were disappointing for economists concerned about inflation and alarming for investors in Indian banks. Mr Chidambaram’s pre-election handouts included more than $15bn loan relief for farmers and higher thresholds for income tax. Bank shares have since fallen sharply, partly because it is not clear how the loan waivers will work in practice and because the plan favours small farmers in arrears over those who have diligently paid what they owed.

Mr Chidambaram also cut excise duties on cars and motorcycles in a bid to support the manufacturing sector, and, as expected, raised spending on education and health.

The Indian government – which believes economic growth will slow to 8.7 per cent in the fiscal year to March 31 from 9.6 per cent the previous year – can argue that it remains fiscally prudent in spite of the stimulus provided by this budget. The official fiscal deficit for 2008-09 is forecast to fall to 2.5 per cent of gross domestic product from 3.1 per cent a year earlier.

Unfortunately, that is not the whole truth. The central fiscal deficit number is flawed because it excludes expensive subsidies for oil, food and fertiliser and does not take into account the deficits of the Indian states. Even the relatively modest official economic growth forecasts may prove too ambitious.

Just as it has shied away from necessary reforms to liberalise the labour market and the financial sector, so the Congress-led coalition has failed to invest heavily in the roads and schools that India desperately needs. Instead, the surging revenues arising from a period of rapid economic growth have been channelled into wasteful subsidies and make-work schemes and often skimmed off by corrupt officials.

India’s budget remains horribly skewed towards unproductive spending. It is true defence spending rose only 10 per cent, compared with a 20 per cent increase for education, but annual military expenditure of $27bn is still excessive in a country with so many poor.

The next shock to the fiscus is likely to be the outcome of the once-a-decade pay commission for the Indian public sector, which is due within weeks and tends to overwhelm the most prudent government’s budgetary defences for two or three years. With an election looming, things can only get worse.

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