Prime Minister Manmohan Singh's embattled government will likely boost spending on social programmes in a populist budget on Monday, even as India is threatened with a potentially ballooning subsidy bill for food and fuel.
Higher spending to appease voters will make it tougher to reach deficit-cutting targets in a year that could see slower economic growth, and could also make policymakers' battle against inflation more difficult.
"Pruning the (fiscal deficit) is tricky, especially when the economy is showing signs of a slowdown, cash-guzzling social sector projects are due to be announced and high commodity prices globally are likely to bloat the subsidy bill," HDFC Bank Chief Economist Abheek Barua wrote in a note.
Unlike in the current fiscal year ending March 31, New Delhi will not be bailed out by unexpectedly strong growth and revenue from the sale of 3G telecom licences.
The government's political imperative not to cut subsidies will be hugely expensive. Food subsidies total nearly $13 billion, or 5 percent of the budget, while fuel subsidies total around $5.5 billion, 68 percent more than a year ago.
Political obstacles, including from within the ruling Congress party, which is increasingly moving to the left, will also discourage any major reforms in the new financial plan, such as allowing more foreign investment in the financial services and retail sectors in Asia's third-biggest economy.
The government has become bogged down in a slew of corruption scandals, and soaring food prices have only made matters worse.
EYE ON ELECTIONS
Finance Minister Pranab Mukherjee, known more as a wily political operator than as an economic reformer, is likely to have growing public unrest in mind as he crafts the new budget.
Polls in states such as West Bengal and Tamil Nadu will determine the strength of the ruling coalition ahead of the 2014 general election. A poor showing by Congress will bolster the opposition and weaken the party's standing with its already unruly allies.
However, increased government spending has spurred demand in India without commensurate growth in new capacity, adding to inflationary pressures.
To offset higher social spending, the budget is likely to increase excise taxes and widen the service tax base, and include expected 400 billion rupees ($8.8 billion) from the sale of state assets.
While growth in Asia's third-largest economy will reach 8.6 percent this fiscal year, and the government is gunning for double-digits, persistently high inflation -- now topping 8 percent -- has stirred opposition backlash and street protests.
Yashwant Sinha, a former finance minister and senior member of the opposition BJP, told Reuters Insider that India should sacrifice a bit of growth to tame inflation.
"I really hope he (Mukherjee) will not be populist, because populism at this point in time will only cause greater harm to the economy in terms of higher inflation, greater harm to the common man," he said.
"It might be sweet in the short term, but it will be very painful in the long term."
DEFICITS AND BUDGET-BUSTERS
India will comfortably beat its fiscal deficit target of 5.5 percent of GDP in the current year thanks to $23 billion in telecoms spectrum auction proceeds -- or roughly 1.5 percent of GDP.
Without that, India would have missed the target, which makes the new year's 4.8 percent deficit goal look optimistic.
The central government is like to borrow about 4.5 trillion rupees ($99.8 billion) from the bond market in the new year, roughly in line with current year forecasts, a Reuters poll found.
With global crude prices above $100 per barrel on unrest in the Middle East, the budget is likely to cut duties on petroleum products to give relief to state oil firms and consumers.
Total spending in the current year is likely to rise by 19 percent, far in excess of a budgeted 8.5 percent, due to a surge in food, fuel and fertiliser subsidies, according to HDFC Bank, which predicts a 10-12.5 percent spending rise in the new year.
A pending food security bill and an expansion of a rural jobs guarantee scheme that would peg wage increases to consumer inflation will add to the spending burden.
The full cost of subsidies for fuel and food won't be known until later in the year, meaning a supplementary budget could end up causing the deficit to balloon even if Monday's budget looks frugal -- if global crude prices stay high and India continues to subsidise diesel and cooking fuels.
Last summer, India freed up petrol prices but has not yet taken the politically unpopular step of subjecting the much more widely-used diesel to market pricing.
"There is a lot of uncertainty on the expenditure front. We won't really know what the bill is until probably in the second half of the year," said Jahangir Aziz, chief India economist at JPMorgan.
While Singh's second administration can claim a few reform successes, including a programme to sell down stakes in state companies, his goverment has mostly lurched from crisis to crisis since being re-elected with high expectations in 2009.
The winter session of parliament was all but shut over opposition demands for a probe into a telecom licence scandal that may have cost New Dehli $39 billion in potential revenue.
On Tuesday, Singh bowed to months of pressure and agreed to an investigation into the scandal that has overshadowed the hype that usually accompanies the run-up to India's annual budget.
Last week, Singh insisted that his reform agenda is alive, but if his record is anything to go by, investors may be disappointed.
Beyond a roadmap for implementation of a much-delayed nationwide goods and service tax, expectations are guarded.
Singh's weak standing means any such measures are likely to be modest or preliminary: steps to boost infrastructure building, bolster the corporate bond market, and speed land acquisition.
"I sincerely hope that in this current Budget, you will see a clearer picture of the reform agendas that our government has. We have not given up, we will persist," he said.
(US$1 = 45.295 rupees)