Troubled India government delivers cautious budget

India's beleaguered government avoided bold reforms in its annual budget on Friday, opting for cautious steps to shore up growth and modest targets to rein in a bloated deficit after a series of political setbacks exposed its fragility.
Government bond yields leapt to their highest in more than 10 weeks and stocks fell, reflecting disappointment with Finance Minister Pranab Mukherjee's half-hearted attack on the worst fiscal deficit among the emerging-market "BRICS".
"I don't see any populist schemes, but this is not a reformist budget either, it is a status quo budget," said A. Prasanna, an economist at ICICI Securities Primary Dealership as Mukherjee wound up his annual speech to a rowdy parliament. Mukherjee unveiled a smattering of anti-deficit measures including an increase in services and excise taxes, saying that, like Shakespeare's Hamlet, he had to "be cruel only to be kind".
Indeed, the pain was felt almost immediately. Tata Motors, India's dominant maker of commercial vehicles, raised prices on cars and trucks in response to the excise duty hike. Mukherjee also called for reducing India's subsidy burden below 2 percent of GDP, from about 2.5 percent, but did not take the politically fraught step of cutting subsidies for petroleum products, which have weighed heavily on government finances especially as oil prices remain stubbornly high.
With no concrete measures to reduce subsidy spending, Nomura said in a note that the government may overshoot its new 2 percent target. Prime Minister Manmohan Singh said after the budget speech that the government would eventually need to "bite the bullet" and raise prices, even if it irked its coalition allies.
But India's political realities cast doubt over the prospects for action anytime soon. The coalition government has been weakened by a string of corruption scandals, while the ruling Congress party was trounced earlier this month in crucial state elections. This week, it faced a rebellion within its own ranks over a proposed rise in railway fares, which fanned speculation that the fragile coalition might fall apart and trigger a snap general election. Cast against this political landscape, Mukharjee's half-measures did little to quiet sceptics about the government's commitment to reform.
"He seems worried about the stability of the government more than trying to revive the economy," said Jagdish Shettighar, an economist with the main opposition Bharatiya Janata Party. The finance minister set a fiscal deficit target of 5.1 percent of GDP for the year that begins in April, down from an expected 5.9 percent in 2011/12. But the current year's deficit ended up far above the 4.6 percent targeted in the budget a year ago, as economic growth slowed and spending ballooned.
Even if India manages to cap its deficit at 5.1 percent, which several analysts doubt, its fiscal gap remains wider than those of BRICS peers Brazil, Russia, China and South Africa. While India's government debt burden is far lighter than the United States or Japan, those countries enjoy ultra-low borrowing costs. US two-year Treasury bonds yield just 0.4 percent. Ratings agency Standard & Poor's said the new budget was "mildly negative" for India's credit rating, noting that the timing remained uncertain for long-awaited reforms, including a goods and services tax, as well as a direct tax code that would streamline tax collection.
With federal elections set for 2014, the budget a year from now is expected to be laden with populist spending, and Fitch Ratings warned that politics may also undermine the discipline needed to achieve the subsidy cuts planned this time around. "Implementation risk is high ahead of federal parliamentary elections in 2014," the ratings agency said. Mukherjee said he expected the Indian economy to grow by 7.6 percent in fiscal 2012/13, up from 6.9 percent in the current year, its lowest in a nearly decade excluding the global financial crisis in 2008. The budget assumes wholesale price index inflation averages 6.4 percent during the year. February inflation was 6.9 percent.
Many foreign investors have lost patience with India's slowing economic growth, inconsistent policies and political instability. Because India runs both budget and current account deficits, it needs to attract overseas investment. The budget set a gross market borrowing target of 5.7 trillion rupees ($113.19 billion), far more than the 5.3 trillion expected, jolting bond investors already fed up with heavy government borrowing.