2004 is ending with a bull run in the stock exchange that we have only rarely seen before. On December 28 the sensex crossed 6,500, 400 points above the peak it had attained last January and 2,700 points above the nadir of 4,800 reached on May 17. Some of this rise is being caused by an inflow of foreign investment. But a great deal, perhaps the major part, is a product of bounding optimism among Indians in the future of the Indian economy.

This optimism is well founded. The macro-economic fundamentals of the economy have seldom been so strong. Everyone knows that our foreign exchange reserves have crossed $130 billion. But not everyone realises that whereas, three years ago, nine-tenths of these reserves consisted of money borrowed in one form or another, today almost half of them are free reserves, wholely and solely owned by the Indian government.

What is better still, the balance of payments is running a sizable surplus for the fourth year in succession. Beginning with $782 million in 2001-2002, it climbed to a whopping $8.72 billion last year and is expected to be close to $5 billion this year despite the rise in oil prices.

There has been much alarm, since August, over the resurgence of inflation. But the rise has taken place only in the wholesale price index, which is a measure of inflation for producers, not consumers. The consumer price index for April to October has risen by only 3.5 per cent. This is actually 0.2 per cent less than the rise that took place last year. Only in the rural areas has it been somewhat higher. That reflects the erratic monsoon we have suffered this year.

It is therefore hardly surprising, therefore that a big wave of private investment is building up in the economy. By September, investment already in the pipeline was 22 per cent above last year. The figure for investment in manufacturing was 31 per cent.

The future also looks good. Last week Chidambaram announced that investment proposals were now 26 per cent above a year ago. In October the rate of growth of industrial production rose to 10.1 per cent, the first time it has gone over 10 per cent since 1996. The growth of manufacturing was even higher at 11.3 per cent. Both figures are 4 per cent above the same month last year. Overall in the first seven months of the year industry has grown by 8.4 per cent (6.2 last year) and manufacturing by 8.8 (6.8).

The composition of growth also portends more growth. The greatest increase has been in capital goods - 19.2 per cent in October and 15.1 for April to October. Last year the figures were 4.9 per cent in October and 9.2 per cent for April to October. The output of Consumer durables has grown by 15. 5 per cent in October and non-durables by 13.4 per cent. Against this the output of basic and intermediate goods has grown by 6.8 and 6.7 per cent respectively. This pattern suggests that there has been a sharp movement by industry towards the production of more sophisticated products with a higher value added component.

In the six lost years of 1997 to 2003, the main constraint on investment was the high rate of borrowing by the government from the banking system. This was crowding out private borrowers by keeping interest rates 6 to 8 per cent above the rate of inflation. Finance minister Chidambaram's most important achievement so far has been to more or less put an end to this practice.

The first seven months' budget figures showed a pruning of the government's non-Plan expenditure to the point where the primary deficit, which is excess of the government's actual consumption expenditure over its revenues, has disappeared and been replaced by a small surplus of Rs961 crore. By contrast, last year, despite a determined effort by the NDA government to cut its expenditures, the primary deficit was still Rs25,000 crore in the first seven months.

The full implication of Chidambaram' achievement becomes clear only when one understands the difference between the primary deficit, the revenue deficit and the fiscal deficit . In contrast to most other countries, the Indian budget has both a current account - the normal definition of the budget - and a capital account, which records capital receipts and outflows. The fiscal deficit is the sum of the deficits or surpluses on the current and the capital accounts. So it is perfectly possible to show a balanced budget, when in fact one has a large current account deficit, by offsetting it against loans taken on the capital account. This was a common practice in the '70s and'80s
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The revenue deficit, on the other hand, measures only the deficit in the current account. This has two major components. The first is the primary deficit. The second is the interest it must pay on its accumulated debt. The latter is also an expense, but mostly goes back into the banking system because it is the banks that buy most of the government's securities. It does not therefore enter the income stream of the economy directly. Banks have to lend the money out to borrowers first. That is basically investment and not consumption.

The primary surplus we have recorded means that the government is not, for the first time in more than a decade, 'crowding out' private investors with its borrowing. The greater availability of bank funds just now will mean that interest rates will not rise, as investment increases, for quite a long time. The boom will therefore last longer and be bigger.