NEW DELHI (Reuters) – The government plans record levels of borrowing next year and will count on surging economic growth to help cut its fiscal deficit, putting pressure on the Reserve Bank of India (RBI) to be more aggressive in its monetary tightening.
Finance Minister Pranab Mukherjee told parliament the government plans to increase market borrowing by 1.3 percent in his $239 billion budget, pushing bond prices lower as investors anticipated a flood of fresh debt supply.
Analysts said the borrowing plan cements the likelihood that the RBI will raise interest rates at its next meeting on April 20 as policymakers scramble to keep surging food inflation from spreading to the wider economy and fueling social unrest.
"Given that the fiscal stimulus withdrawal was not strong, the Reserve Bank of India (RBI) may have to be more aggressive in its policy tightening," said Robert Prior-Wandesforde, HSBC senior Asian economist in Singapore.
Many watchers praised the plan to reduce the fiscal deficit to 5.5 percent of GDP in the new year from 6.9 percent this year, with further declines in coming years, and a RBI deputy governor said the budget addressed concerns on fiscal discipline.
Mukherjee announced plans to hike spending on social and agricultural programmes popular among voters, and adjusted taxes to put more money in the hands of the middle class.
But some analysts said India had missed a chance to take more aggressive fiscal measures as Asia's third-largest economy gathers speed, reinforcing perceptions that the coalition government may not have the heart to make tough decisions.
The budget focused on keeping the economic recovery robust, but there was little mention of reforms, such as freeing state fuel and food subsidies, that investors say could help India rival China's years of double-digit growth rates.
Some heavy economic stimulus brought in last year was trimmed, but not chopped, with rollbacks of certain tax breaks.
"The first challenge before us is to quickly revert to the high GDP growth path of 9 percent," Mukherjee told parliament.
The 74-year-old minister is known for deftly appeasing India's myriad of caste and ethnic groups rather than pushing visionary reforms. The decision to spend more on agriculture in particular is bound to please a key rural support base that helped re-elect the Congress-led government last year.
RATE HIKES AHEAD
Financial markets focused on whether the government would pay more than lip service to imposing fiscal discipline and start weaning itself off aggressive deficit spending that risks pushing up companies' borrowing costs.
Usha Thorat, a deputy governor at the Reserve Bank of India, said the deficit outlook was in line with expectations.
"From our point of view one of very important thing was the fiscal consolidation. So, I think one would say it is positive for lesser inflation," she told reporters.
The deficit figure was slightly better than a Reuters poll forecast of 5.6 percent and in line with government expectations.
Gross borrowing for the new fiscal year will total 4.57 trillion rupees ($99 billion), below a Reuters poll forecast for 4.61 trillion but above a record 4.51 trillion rupees expected in the current year ending in March, Mukherjee said.
"With the fiscal deficit expected to be still high over the next fiscal year, it is clear that the onus will be on the RBI to hike rates in coming months in order to move policy settings closer to neutral and to deal with emerging inflation pressures," said Brian Jackson, strategist at Royal Bank of Canada.
SPENDING AND REVENUE
Total government spending will rise nearly 9 percent in the next fiscal year, while revenues will rise nearly 18 percent as the economy recovers.
In one politically charged effort to raise revenue, the government said it would raise prices of gasoline and diesel fuel for the first time in 7 months.
Mukherjee also pencilled in expected revenue of 400 billion rupees from the sale of stakes in government companies, a figure that some observers said was ambitious.
"The government will need to be very aggressive to meet that target," Goldman Sachs analyst Tushar Poddar wrote in a note.
India's economy grew 6 percent in the December quarter, short of a Reuters poll forecast of 6.8 percent, as farm output fell 2.8 percent after a poor summer drought.
The slowdown in spending growth may help ease inflation, some analysts said. High food prices helped push wholesale price inflation to 8.56 percent in January.
Opposition lawmakers boycotted much of the budget session, saying government plans to increase fuel prices would further add to the woes of millions of Indians hit by high prices.
The yield on benchmark 10-year government bond fell as much as 6 basis points earlier on Friday but erased that move on worries over high government borrowing. The yield on the benchmark 10-year government bond ended at 7.86 percent, three basis points higher than Thursday's close.
Stocks ended 1 percent higher after Mukhjeree announced measures aimed at increasing domestic consumption.
(Reporting by Abhijit Neogy, Manoj Kumar, C.J. Kuncheria, Bappa Majumdar, Rajesh Kumar Singh, Jeanette Rodrigues and Suvashree Dey Choudhury; Writing by Tony Munroe; Editing by Alistair Scrutton, Kim Coghill, John Stonestreet, Ruth Pitchford)
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(For more stories and complete coverage of India Budget 2010, click here)
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