The impossible may be about to happen: India's fiscal problem could become manageable. And the difficult target mentioned in the new fiscal responsibility law, of eliminating the central government's revenue deficit (3.6 per cent of GDP this year) in no more than four years, could be achieved.

The magic key, or rather keys, have been provided by low interest rates and that new-fangled creature called the service tax.

When interest rates were in the stratosphere six or seven years ago, the government's interest bill on public debt was climbing by about 18 per cent annually-faster than GDP growth.

This growth rate fell to 10 per cent at the turn of the century, and then in the three-year period 2001-04 has been growing at no more than 7.3 per cent. For next year, the Budget provides for just a 4 per cent increase in interest payments -- at a time when GDP is expected to grow by over 12 per cent (in nominal terms, i.e including inflation).

This makes a huge difference to the deficit, because interest payments are by far the single largest item of expenditure for the government.

If interest rates remain low, and interest payments therefore grow slower than over-all tax revenue, government expenditure and GDP (as has been the recent trend), then some fairly simple calculations demonstrate that, over the next four years, the share of interest payments will fall by at least 1 per cent of GDP. That alone is about a third of the fiscal correction required.

Turn next to the service tax, the revenue from which in the last four years has grown from Rs 2,000 crore (Rs 20 billion) to Rs 8,300 crore (Rs 83 billion), and will climb further next year to Rs 13,500 crore (Rs 135 billion).

At that rate of progression, it isn't difficult to see service tax revenue climbing to Rs 50,000 crore (Rs 500 billion) by the target year of 2007-08 -- especially if a VAT system is introduced by then and the service tax rate is doubled from today's 8 per cent to the central excise rate of 16 per cent (there is, after all, no reason why services should be taxed at half the rate for products).

Part of the growth in service tax revenue will come from greater coverage -- and computerisation is being put to good use here. The government has encouraged e-filing of the service tax, but this automatically requires that everyone in the tax chain has a permanent account number.

Ergo, even the small businesses that proliferate in India get caught in the net, because they either provide services to, or take services from, large companies.

So the service tax will repeat the history of the sales tax: what began as a small tax with limited scope, turns out to have massive revenue potential. If that potential is realised, as it promises to be, then we could see over 1 per cent of GDP being collected through this tax. That takes us two-thirds of the way home to a zero revenue deficit.

The rest then becomes easy. Because Vijay Kelkar (the author of the 2002 reports on reforming India's tax system) has argued that tax revenues climb 15 per cent if the quality of tax administration improves; that at least is the international experience. If something like that happens in India as well, then the goal is achieved.

Even if it is not, if the finance minister is able to hold down the subsidy bill (as has been done this year), it is a big step forward. A peace dividend from Pakistan could also see savings in defence expenditure.

In other words, there are several options available, once service tax revenues and savings on interest payments deliver the big bang benefits.

That will then leave the central government with a deficit on the capital account. But since this by definition goes towards the creation of capital (like infrastructure: power stations, roads, etc), no one can cavil at such a deficit.

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