India to Put Investors Before Voters in Election-Year Budget

India Finance Minister P Chidambaram
Sam Panthaky | AFP | Getty Images
India Finance Minister P Chidambaram

India's finance minister had a bruising battle with cabinet colleagues in the run-up to the budget he unveils this week, rebuffing demands for pre-election spending and insisting on austerity to shore up investors' faith in a troubled economy.

Aides to P. Chidambaram said the eloquent Harvard-educated lawyer finally convinced leaders of his Congress party that more profligate spending would make a sovereign rating downgrade to 'junk' status inevitable and could trigger an economic meltdown.

In pushing for austerity, officials said Chidambaram met no opposition from Prime Minister Manmohan Singh - architect of the 1991 economic reforms that led to the "Incredible India" story - or from the welfare-minded leader of the Congress party, Sonia Gandhi, pointing to increasing acceptance of the depth of India's economic problems.

"He wants to send out a credible and strong signal that India is on the right track," said one senior official privy to the secrecy-shrouded preparations for the 2013/14 budget. "He apprehends that yet another failure to honor fiscal commitments could end the India story."

Chidambaram has staked his reputation on meeting deficit cutting targets, embarking last month on a road show of financial centers where he sought to reassure foreign investors that India was serious about getting its fiscal house in order.

Several officials involved in budget planning told Reuters that tackling the bloated fiscal deficit will be the centerpiece of Chidambaram's presentation to parliament on Thursday.

They said his budget has also been crafted to avoid unnerving investors, who were dismayed last year by plans to tax merger and acquisition deals retrospectively and clamp down on tax evasion.

Together with a widening fiscal gap, the tax moves triggered a flight of capital from Asia's third-largest economy. The rupee was hammered and, with exports and foreign direct investment slowing, fears of a balance of payments crisis mounted.

New Delhi missed its fiscal deficit target of 4.6 percent of gross domestic product (GDP) in 2011/2012 by 1.2 percentage point because of over-spending on social welfare and subsidies, prompting credit rating agencies to threaten a downgrade that would make India the first of the BRICS emerging economies to lose its investment-grade status.

(Read More: India's Investment Malaise Thwarting Quick Economic Rebound)

Chidambaram has repeatedly pledged to lower the deficit to 5.3 percent of GDP this fiscal year and 4.8 percent in 2013/14. But with economic growth languishing around 5.5 percent after the sharpest slowdown in a decade, the finance minister cannot rely on tax revenues to meet his goals.

The finance minister told a budget meeting last month that India had no alternative to meeting the fiscal deficit target and a slippage could have dire consequences, according to a senior bureaucrat who was present at that meeting.

Officials told Reuters that he has already slashed public spending in the current fiscal year that ends in March by some 9 percent from the original target and for 2013/14 he plans to cap it roughly at the same level.

In a Reuters poll conducted earlier this month, 18 out of 23 economists predicted that the focus of Chidambaram's budget speech will be on slashing subsidies and government handouts.

Letters to the Minister

That is not what other ministers wanted from the budget as the government - mired in corruption scandals and widely derided as incompetent in the face of the economic slowdown - faces a struggle for re-election in polls due by May, 2014.

Officials say that the rural development minister argued in one letter to Chidambaram against spending cuts that would hit housing and road construction in poor rural areas, on which the Congress party has traditionally relied for votes. He wrote again this month to avert a possible cut in funding to a rural employment guarantee scheme.

The tribal affairs minister wrote twice to Chidambaram to plead against cuts in welfare spending, worried that they could alienate tribals, who traditionally vote for the ruling Congress party. And the defense minister complained that budget cuts would hobble a grand plan to modernize India's armed forces.

(Read More: India Inflation Slows to More Than 3-Year Low in January)

Chidambaram wants these ministers and the railways minister to prioritize their spending, focusing primarily on critical projects, but has held out the prospect of additional funding if revenues pick up later in the year.

In a measure of the many demands Chidambaram faced, the Planning Commission - a powerful body of government advisers - sought an increase of at least 15 percent in capital spending over this year's original target to underpin growth. But he was ready to provide for a rise of just about 6 percent from actual spending.

"You can provide money only if you have money," said a top official at the Finance Ministry.

As well as keeping a lid on expenditure, Chidambaram is expected to announce steps to maximize revenues through more efficient tax collection, fewer tax exemptions and higher proceeds from the partial privatization of state-controlled companies.

But, wary of dealing another blow to investors' confidence, proposals for higher taxes on the super-rich that were floated early this year appear to have been ruled out.