>BUDGET PREVIEW (HSBC)

Budget preview: Easy does it

• Populist budget likely as India builds a welfare state of sorts
• Structural budget deficit set to rise…
• …which may worry RBI, rating agencies and bond market

Having already introduced two stimulus packages, seen the budget deficit exceed 6% of GDP, watched the Reserve Bank of India slash interest rates and witnessed some encouraging signs of recovery one might have thought the government would be content to present a neutral budget on 6 July. This seems unlikely, however. We expect the budget to contain several expansionary measures, with little or nothing in the way of action to address the worrisome structural deficit. If we are right, then the RBI, rating agencies and bond market players may be less than enthusiastic in their reaction.

While markets have taken the view that Congress was the big winner from the general election, a better interpretation of the result is that it was the left of the Congress party that was the real winner. This may seem a subtle difference but it is one with very important implications. In particular, it probably means that the top priority of the government is to continue building a welfare state of sorts, with meaningful pro-market reform and structural budget adjustment taking more of a backseat than many are assuming.

In line with this, we expect help for the poor to take centre-stage in the budget. The government has already suggested that it will guarantee the provision of basic foodstuffs at low prices to all poor families as well as funding the construction of millions of new homes in rural areas. It may also extend the popular National Rural Employment Guarantee Act to include the urban poor, while promising additional infrastructure, preferably via public-private partnerships. The corporate sector could enjoy higher depreciation and/or investment allowances for spending on machinery and equipment.

Despite the prospect of all this additional spending, we wouldn’t be surprised if Mr Mukherjee forecasts a fall in the central government’s budget deficit in 2009/10. The Finance Minister will attempt to square the circle by arguing that the various programmes will be “financed from stronger economic growth” (expect some bullish growth projections), with the sale of government stakes in some state-controlled companies also helping out. The trouble with this approach is that many of the spending measures are likely to be permanent in nature while the divestments are one-off. In other words, the structural budget deficit is in danger of rising when it should be falling. No doubt the government will commit to a medium-term programme of deficit reduction, but given the eventual failure of the first Fiscal Responsibility and Budget Management Act one might be forgiven for doubting the credibility of FRBM (2).

To see full report: BUDGET PREVIEW