Govt ups spending to spur growth, deficit hits markets

By Surojit Gupta and Tony Munroe

NEW DELHI (Reuters) - The government ramped up spending for this fiscal year to support a fragile economic recovery, spooking stock and bond markets with plans for record borrowing and the biggest budget deficit in 16 years.

Investors had hoped the new government would use a strong re-election mandate to push through pro-market reforms, but the budget it unveiled lacked major policy changes and focused on increased borrowing and spending to aid farmers and the poor.

Stocks tumbled nearly 6 percent, bond yields spiked and the rupee fell 1.4 percent after Finance Minister Pranab Mukherjee, sticking to the ruling Congress party's theme of "inclusive growth", said the fiscal deficit for the year ending March 2010 would increase to 6.8 percent of gross domestic product (GDP).

The stocks selldown was the biggest in six months.

With the developed world mired in recession, big emerging economies led by China -- on track for 8 percent growth this year -- and India are expected to help drive worldwide recovery. Both economies have been fuelled by stimulus spending to spur domestic demand.

Investors had expected India's fiscal deficit to grow to up to 6.5 percent, from 6.2 percent in the previous year. However, analysts said the hefty borrowing plan threatens to drive up the cost of credit and choke off economic growth.

The first budget of Prime Minister Manmohan Singh's new administration was seen as a roadmap for how he will govern for the next five years after his Congress party-led coalition was re-elected by an unexpectedly decisive margin in May.

"While the thrust on agriculture, infrastructure, etc., augurs well from a long-term growth perspective, the fiscal profligacy is quite obvious in the near term," said Rupa Rege Nitsure, chief economist at Bank of Baroda in Mumbai.