Modi's populist budget to weigh on next government: economists

By Suvashree Choudhury

NEW DELHI (Reuters) - The pre-election budget of Prime Minister Narendra Modi's government, including handouts for farmers and tax cuts for the lower middle class, is likely to weigh on whoever forms the next administration, economists warned on Friday.

The government abandoned its budget deficit target for the next financial year ending March 31, 2020, saying it now aimed to come in at 3.4 percent of gross domestic product against an earlier goal of 3.1 percent, as it tries to tackle a rural incomes crisis partly caused by low crop prices. But it did keep the target at 3 percent for the 2020-21 year.

Economists fear some of the assumptions built into the math for those goals are too aggressive - especially its forecasts for strong tax revenue growth.

That means they are unconvinced that the next government - whether Modi wins the election, due by May, or not - will hit the deficit goals in those two years.

"The next government will likely inherit some fiscal risks as revenue expectations look ambitious," said Mitul Kotecha, senior emerging market strategist at TD Securities in Singapore.

"If there is no real pick up in tax collections, then the next government will need to take further steps to stick to the fiscal deficit target."

That could include cutting capital spending, which could hurt an economy that badly needs improved infrastructure.

It also gives the next government little wiggle room if the global economy keeps slowing.

Modi's Hindu nationalist-led government pledged 750 billion rupees ($10.56 billion) to make direct payments to farmers owning less than two hectares of land, and allocated more money for rural jobs and development, such as better roads.

The lower middle class were helped as the income tax threshold has been raised to 500,000 rupees from 250,000 rupees.

Many of the measures were intended to put money into pockets quickly ahead of the election. Modi faces a re-election battle after anger about low farm incomes contributed to defeats for his ruling Bharatiya Janata Party in state elections at the end of last year and as opposition parties, including Congress, appear to be gaining support.

To support its spending the government is banking on an "ambitious" 18 percent increase in goods and services tax collection to 7.61 trillion rupees ($106.81 billion) in 2019/20 while it aims to borrow a higher-than-expected 7.1 trillion rupees from bond markets.

"I think, ultimately, their spending plans look very unfeasible to me, so I wouldn't be surprised to see spending get cut later in the year," said Shilan Shah, senior India economist at Capital Economics in Singapore.

Investors are also lowering expectations for rate cuts by the central bank because of the concerns about whether the government can reach the budget targets.

In a sign of waning market sentiment, the 10-year benchmark bond yield ended at 7.61 percent, up 13 basis points from Thursday, the biggest single-day selloff since last September. The rupee also weakened to 71.26 to the dollar from Thursday's 71.09, though the broader NSE stock index ended up 0.59 percent.

COMPLEX ALLIANCE

For Modi, the optics of the budget will be as important as the implementation of many of the measures. It will be for the next government to deal with any fallout.

It becomes an even bigger task if no single political party gets a clear majority in the election and there is a coalition government either led by the BJP, Congress or another opposition party.

"The catch here is, even if the BJP does not come back to power in May, the new government will also implement this scheme because no government will want to look anti-poor or anti-farmer," said Garima Kapoor, economist at Elara Capital in Mumbai.

Investors will be putting pressure on the next government to be prudent but that may be easier said than done if a complex alliance ends up in power.

"Investors will look for signs of fiscal consolidation from the new government even if it is a weaker coalition," said Kotecha. "However, fiscal consolidation is harder in coalition politics due to additional demands from various parties. Markets will likely be more nervous ahead of elections."

(Reporting by Suvashree Dey Choudhury; Editing by Martin Howell and Janet Lawrence)