NEW DELHI (Reuters) - Falling oil prices have been a major windfall for India: Just weeks ago it faced failing to meet fiscal deficit targets, but can now expect a budget that not only hits its targets, but also provides extra cash to support reform.
The coming budget for fiscal 2015/16 (April-March), which will be unveiled on Feb. 28, is widely seen as a test of Prime Minister Narendra Modi's ability to lead economic reform.
Fortunately for Modi, the economic climate has handed him a chance to pass that test with flying colours: Budget planners are optimistic that he will set Asia's third-largest economy on a path for growth of 7 percent to 8 percent over the next two years.
"The situation is far better now than in December," said one finance ministry official, who spoke to Reuters despite a ban on contact with the media in the secrecy-shrouded run-up to the presentation of the annual budget. "The budget will deliver on Modi's promise of better days for the economy."
The halving of global oil prices since mid-2014 has allowed the Modi government to raise diesel and petrol fuel taxes and cut diesel prices by 25-30 percent – a windfall gain for households as well as businesses, and dampening inflationary pressures in the economy.
The government has pocketed nearly $3.5 billion from repeated hikes in tax on fuel while the central bank cut interest rates by 25 basis points last month, and has hinted at further rate cuts if inflation declines.
Modi was elected last May on pledges that he would create jobs and rejuvenate the sagging economy, but investors and economists were disappointed by his first interim budget in July and a distinct lack of early progress in fixing structural economic problems, so the slide in oil prices has been a boon for one of the world's top crude importers - and Modi's administration.
"Let's accept that I am lucky, but you have saved money. If Modi's luck is benefiting the people, what can be more fortunate?" Modi said in a speech last weekend.
Officials say lower fuel subsidies along with recent diesel tax hikes could together add almost 1.1 trillion rupees ($18 billion) to the 2015/16 budget, and they plan to spend about 500 billion ($8 billion) of that on Modi's flagship infrastructure and manufacturing initiatives.
With more money flowing into India's stock market after the European Central Bank unveiled an estimated 1.1 trillion euro stimulus, the government is ramping up its programme of selling stakes in state companies. It raised $3.65 billion from a 10 percent stake in Coal India last week and is moving fast to line up others.
As finance ministry officials work feverishly to have the budget presentation ready on time, investors appear to be upbeat.
The benchmark BSE share index has risen more than 5 percent this year, making India one of the best-performing markets. Foreign investors have placed about $5.5 billion in India's debt and equity markets.
The fall in oil prices has given Finance Minister Arun Jaitley headroom for subsidy reforms that would rein in spending on cooking gas, fertilisers and food subsidies and reduce the fiscal deficit to 3.6 percent of GDP from an estimated 4.1 percent for the current financial year.
Jaitley is also likely to unveil tax reforms, such as a goods and service tax that would absorb most federal, state and local taxes by April 2016, ease tax rules on transfer pricing, and address some overseas investors' concerns.
To be sure, problems in the economy remain, and Modi is under pressure to implement measures to revive consumer demand and give corporate India the confidence to invest. "Everyone knows that the honeymoon period for government will not continue forever, we have to speed up reforms before it is too late," said another official, who has direct knowledge of onging budget discussions.
The budget will support Modi's "Make in India" drive with tax incentives for the manufacturing sector, lower import taxes on production inputs and higher duties on final products, officials said. Taxes on gold imports could also be reduced following a sharp decline in the current account deficit.
Editing by John Chalmers and Eric Meijer