Policy-making is easy when inflation is low and growth high, but very hard when things are the other way around. Like in India right now where inflation has already inched to above 7% and industrial growth is declining. And as December grinds on, the main policy issue is: which of these should the Finance Minister target first, inflation or growth?

The dilemma is stark: in the short run, success in one can only come at the expense of the other. But let's assume that inflation weighs more heavily on political minds and that the government is therefore far more likely to target inflation immediately and worry about growth later. If so, what can we expect?

The monetarist approach to bringing inflation under control is simple: reduce money supply and raise interest rates. So should the RBI now tighten monetary policy to control inflation? When the rate of economic growth was comfortable, the RBI only had to worry about inflation and could tighten monetary policy if necessary. When growth is low, as at present, a higher interest rate may help to reduce liquidity and lower price rise, but it would hurt the industry further.

To turn the industrial slowdown into a full-blown recession, perhaps all that needs to be done today is to raise interest rates. So tightening money may not be an attractive proposition. Also, RBI Governor Bimal Jalan has promised that interest rates will not be changed and that inflation cannot be the only objective of the central bank. This indicates that the RBI is unlikely to tighten monetary policy.

But what about fiscal policy, then? What policy choices does the government have, particularly in terms of financing the deficit?

Let us for the moment assume that the Finance Ministry uses every possible means to keep the deficit under control. But there will still be a policy conflict between controlling inflation and raising growth. The larger the market borrowings of the government, the higher would be the pressure on interest rates.

The alternative is monetisation of a part of the debt or deficit financing, as it is popularly known in India. The government could borrow from the RBI or, in other words, print money. By reducing the share of financial savings being pre-empted by the government, monetisation frees up resources that can be lent to the private sector. It not only reduces the interest burden on old debt by lowering rates, it reduces the real debt as prices are higher. It raises GDP as more and more projects become attractive when interest rates fall.

Also, given that the current underlying inflation rate is still low, deficit financing may not translate into an increase in prices for a long time. There is usually a time lag involved in the transmission of monetary policy. One would hope that the time it takes for higher money supply to translate into higher prices is long enough so that deficit financing starts pushing up prices, if it does, only after the current supply shock inflationary phase is over.

The trouble though is that while monetisation may not have been an unacceptable option, say last year when the inflation rate was just over 3%, it may not be a very popular option today when the rate has already crossed 7%.

Even though the underlying rate is low, it is the headline rate that determines the popularity of a measure. Also, considering that this means of mobilising resources, which was widely used in the 80s, has been out of fashion in the 90s, and it may be difficult for the Finance Minister to revert to it. Indeed, it may be said that the Finance Minister lost his chance to reduce the overall size of government debt when he did not consider monetisation as the preferred option in the last two budgets when inflation in the country was low. It may have found favour more easily then.

So, what can the finance minister do in this budget? Either, he can borrow to the full extent of the fiscal deficit in the market and let the size of government debt put pressure on interest rates and hope that some miracle would ward off the recession. Or, he can monetise part of the deficit, reduce the pressure on interest rates and lower public debt. And although this may raise a few eyebrows, if inflation does not go up further during the year, his gamble might pay off.