The Congress led UPA Government announces its annual Budget next week, striving to keep the deficit in check while increasing spending to improve living standards in rural India.
Analysts say the Government, which took power in May, could fund the higher expenditure on health, education, infrastructure and the rural sector with higher tax revenues rather than compromise on the already-large deficit.
But it has to walk a fine line -- raising taxes may be a disincentive to enterprise, but there is precious little room to find extra money. Better tax administration may be one answer, analysts say.
"It is the best time to start reforms to raise the tax-GDP ratio," said economist at Standard Chartered Bank Kishlaya Pathak, adding that it could also serve to dampen inflationary pressures in Asia's third-biggest economy.
India's economy has posted one of the highest growth rates in the world, expanding by 8.2 per cent in the year through the January-March quarter. This compares with the previous decade's average of 5.8 per cent a year.
However, Government tax receipts have not kept pace and are less than 16 per cent of GDP, much lower than the 27.5 per cent-level in South Korea, Asia's next largest economy.
"What markets will be watching for in this Budget is how the Government widens the tax base, and whether the attempt goes so far as to become a disincentive to enterprise," said head of Singapore-based Robust Economic Analysis Prasenjit Basu.
{{/usCountry}}"What markets will be watching for in this Budget is how the Government widens the tax base, and whether the attempt goes so far as to become a disincentive to enterprise," said head of Singapore-based Robust Economic Analysis Prasenjit Basu.
{{/usCountry}}Parts of a blueprint prepared in 2002 by a former IMF executive director, Vijay Kelkar, are expected to be implemented with an aim to simplify the tax structure, cut widespread tax exemptions and widen the net so more people pay tax.
The higher revenues are required to finance the Government's plan to boost health care and education spending almost ten-fold to 9 per cent of GDP from less than one per cent now.
DEBT BURDEN
Congress came to power after India's rural voters overwhelmingly rejected the previous BJP-led UPA govt, upset that they had not reaped much benefit from growth concentrated mostly in urban centres.
The new Government has said it will increase rural spending to address these concerns.
But analysts say the Government cannot fund this expenditure by borrowing because interest payments to service existing debt already consumes nearly half of India's tax revenues.
Currently, Government bond issues help cover a combined state and Union's fiscal deficit of around $54 billion a year -- nearly 10 per cent of GDP, one of the highest in the world.
"It will be interesting to see how they balance the two objectives of narrowing the fiscal deficit and channeling more funds into the rural areas," said portflio manager at firm which has about $300 million invested in Indian stocks Foreign and Colonial, Sam Mahtani.
SERVICE SECTOR
Part of the additional funds could come from the services sector, the fastest growing segment in the economy, which currently accounts for only five per cent of taxes.
"Widening of the service tax net could help bridge the revenue gap. Since services account for about half of GDP, they could provide a potentially large dose of revenue over the next couple of years," said head of proprietary trading at ICICI Bank Neeraj Gambhir.
While fund managers consider reining in the fiscal deficit a priority, they say the major driver of foreign investments will be the tone on structural economic reforms.
"The fact that most of India's deficit is financed locally makes it less risky than emerging markets like Turkey and Brazil, but much will depend on signals from the Budget that reforms will continue," said Mahtani.