Will India's Budget End Talk of Ratings Downgrade?

Gurinder Osan

The Indian government is expected to opt for prudence over populism in the country's national annual budget due out on Thursday as it seeks to restore its credibility among global investors, but will it be enough to finally put an end to talk of a ratings downgrade for Asia's third largest economy?

The budget will be viewed as a positive step by the ratings agencies, reducing the chances of a downgrade ahead of the 2014 national elections, said Robert Prior-Wandesforde, head of India & South East Asia economics at Credit Suisse.

"We expect Finance Minister Chidambaram's budget to err on the side of prudence, incorporating a modest tightening of the underlying fiscal stance after a bigger squeeze in 2012/13. This should help pacify the rating agencies," Prior-Wandesforde said, referring to the end of the year deceleration in government spending.

The country's poor track record in managing its deficit has been of top concern for credit ratings agencies, with both S&P and Fitch downgrading their outlook on India to negative watch last year.

Rated at one notch above junk, India is faced with the prospect of being the first BRIC nation to have its credit rating reduced to non-investment grade if it fails to demonstrate better restraint with spending.

The government's budget deficit target – an indicator of consolidation efforts – is forecast to be set at 4.8 percent of gross domestic product (GDP) for the coming fiscal year ending in March 2014, down from 5.3 percent set for the current fiscal year, which many experts think it could overshoot.

To achieve this, Finance Minister P Chidambaram will turn to a mix of measures to rein in spending and raise revenues, say experts, plus come up with ways to woo investors to India, where growth is lagging at multi-year lows.

(Read More: India Tackles Fuel Subsidies to Ward Off Downgrade)

Since returning to his post Chidambaram has embarked on efforts to both revive investment and cut back on spending. In September the government embarked on what was billed as "big bang" reforms cutting fuel subsidies and opening up sectors to foreign money.

Last month Chidambaram in Singapore on a day trip to woo investors, made a case for a credit ratings upgrade for the country, telling CNBC that they could be forced to change their mind after he presents the budget.

(Read More: Indian Finance Minister Makes Case for Ratings Upgrade)

Devil Is In The Detail

While Sonal Varma, India economist at Nomura, expects the government to deliver an "austere" budget on paper, she said its creditability will hinge on the underlying assumptions on gross domestic product growth, subsidies and asset sales.

Sales of government shares in several companies, for example, often undershoot initial government targets. Government divestment proceeds, for example, for fiscal year 2013 are expected to have reached 270 billion rupees, ($ 5 billion) according to Nomura, compared to the initial target of 300 billion rupees.

"Since 2013 is a pre-election year, we think budget projections should be taken with a pinch of salt…Rating agencies will sift through the finer budget details to judge India's sovereign credit ratings," said Varma.

Former Indian finance secretary, S Narayan, told CNBC that ratings agencies will likely pay close attention to the feasibility of the plans, particularly on the subsidy reduction front.

India's moves to cut back on subsidies have often met with staunch public opposition leading the government to rollback its plans.

(Read More: ProtestersSet Cars, Truck on Fire in India Strike )

"The credibility of the numbers Chidambaram puts out will be looked at very, very closely. If he puts in a figure which is way unrealistic for fuel and fertilizer subsidies, then it's a worry," he said.