Media playback is unsupported on your device Media caption Nick Clegg: "We confounded those who said coalition government was impossible"

The Liberal Democrats have not "lost our soul" by going into coalition with the Conservatives, party leader Nick Clegg has said.

In his conference speech, he urged members to "hold our nerve" by serving a full five years in government.

Mr Clegg, the deputy PM, backed planned government spending cuts as the "only choice" for improving the economy.

He also pledged to allow cash-strapped councils to borrow more money to fund large-scale projects.

The 37-minute speech followed a conference defeat for the party leadership on Monday over its backing of the Conservative policy of introducing "free schools", outside of local authority control, which opponents argued was "socially divisive".

'So, so proud'

And it came amid accusations from one of his own MPs that ordinary members are being ignored, with the Lib Dems at risk of becoming a "dictatorship".

In his address to delegates in Liverpool, Mr Clegg defended the partnership with the Tories, saying: "We confounded those who said that coalition government was impossible. We created a government which will govern and govern well for the next five years.

"Of course there are those who will condemn us. We are challenging years of political convention and tradition and our opponents will yell and scream about it.

"But I am so, so proud of the quiet courage and determination which you have shown through this momentous period in British political history.

"Hold our nerve and we will have changed British politics for good. Hold our nerve and we will have changed Britain for good."

He said: "We will take risks in government. But we will never lose our soul. We haven't changed our liberal values. Our status is different but our ambition is the same."

Mr Clegg praised Prime Minister David Cameron for thinking "beyond his party", adding: "In life, two heads are usually better than one."

But he delivered what will be seen as a coded criticism of previous Conservative economic policy, saying: "We will not repeat the mistakes of the 1980s, in which whole communities were hollowed out."

The cuts programme, to be outlined in October's spending review, would not deliver "smaller government" but "a liberating government", allowing people to run their own lives, Mr Clegg argued.

He stressed the Lib Dems and Tories remained distinct, despite being in coalition, adding: "But for this parliament we work together to fix the problems we face and put the country on a better path. This is the right government for right now."

ANALYSIS Sometimes leaders aim their conference speeches more at the country than at their own party - this was not one of them. Nick Clegg spent most of his 37 minutes urging his party to hold their nerve, stick with it and focus on the long term, which he said would deliver a country in 2015 that was strong, fair, free and full of hope. In the meantime, there was an interesting softening of the language on the upcoming cuts. For months the coalition, and in many cases fronted by Lib Dems, has been ratcheting up the rhetoric on the severity of what's to come. Before the election, even Nick Clegg was talking about "savage cuts". Today he rejected the "slash and burn" approach, and promised the cuts would be "fair and balanced." He also laid down a challenge to those Tory backbenchers who would like to see the state shrink. These cuts weren't about reducing the size of the state, according to the deputy prime minister, though with 600,000 public sector jobs due to vanish in the next few years, some may take exception to that assertion. Nick Robinson: Defensive speech Party conferences 2010 Send your comments

He argued: "We've always been the face of change. We are now the agents of change."

In the only policy announcement of the speech, Mr Clegg promised to allow councils to borrow money against the predicted extra business rates they will gain from large-scale building projects.

The would be the "first step to breathing life back into our greatest cities", he said.

Currently, councils can only borrow against future income that is guaranteed.

There are reports that many grassroots Lib Dems are unhappy at the coalition agreement, fearing that their party is being subsumed by a Conservative cuts agenda.

Mr Clegg was backed by former Lib Dem leader Lord Ashdown who told BBC Radio 4's Today programme any doubts he had about the coalition "lasted about an hour" and spending cuts would be "fairer" because of the party's influence.

However, backbench MP Mike Hancock has written an open letter to Mr Clegg, warning against attacks on benefits and complaining that policies which were not in the coalition agreement - like raising VAT - had been adopted without approval.

"I am sure you agree with me that we must not have dictatorship of the party by 20 Lib Dem ministers. I hope that you will use your leader's speech to the party conference to put to rest both these concerns," he wrote.

'Tough on tax cheats'

On Sunday, another former Lib Dem leader Charles Kennedy told the BBC there was a "legitimate argument" to be had over the speed and scope of cuts aimed at reducing the £155bn budget deficit.

Most Whitehall departments have been told to plan for savings of between 25% and 40%.

Labour argues that the plans could undermine the economic recovery and damage front line services, hitting the poor hardest.

Mr Clegg used his speech to repeat the promise made by the Lib Dem Chief Secretary to the Treasury, Danny Alexander, to target rich tax-avoiders in an effort to reduce the deficit.

He said: "We all read the headlines about benefit fraud. We all agree it's wrong when people help themselves to benefits they shouldn't get. But when the richest people in the country dodge their tax bill that is just as bad.

"Both come down to stealing money from your neighbours. We will be tough on welfare cheats. But unlike Labour, we'll be tough on tax cheats too."

Mr Hancock described the speech as a "golden opportunity that was lost", telling BBC Radio 4's The World Tonight that people on benefits would have found Mr Clegg's words "very depressing".

The Lib Dem leader is leaving the conference on Tuesday, as he is due to attend a United Nations summit in New York on reducing world poverty.