A modest widening of that nature would calm investors
worried that the government may slip away from its
judicious spending. Traders say bond yields could fall
10 to 15 basis points, while shares could hit new record
highs. Gains could be more pronounced if India sticks to
its 3.0 percent target.
But a deficit above 3.2 percent could hit shares and
send bond yields up by 20-25 basis points, depending on
the size of the blowout, on fears of populist policy
ahead of next year's elections.
Markets remain nervous after the government's annual
economic survey on Monday suggested "a pause" in fiscal
consolidation, sending bonds plummeting.
"I think the budget will be focused on both investors as
well as the common man," said A. Balasubramanian, chief
executive officer at Aditya Birla Sun Life Asset
Management, adding he expects a deficit of 3.2 percent.
"The government will take care so that the budget is
neither inflationary nor fiscally less prudent."
A prudent budget could also soothe the Reserve Bank of
India, which holds a policy review on Feb. 6-7 amid
worries it could raise rates in coming months after
inflation hit a 17-month high in December, well above
its 4 percent target.
CRITICAL JUNCTURE
Benchmark 10-year bond yields have fallen 135 bps and
the NSE share index has surged 55 percent since Modi
took power in May 2014.
But a recent spike in inflation, tightening cash
conditions, and worries about fiscal slippage have sent
the 10-year bond yield up more than 80 basis points
since July, the biggest move since the 2013 rupee
crisis.
Stocks have been more resilient, gaining 4.9 percent
this year and hitting records amid signs earnings are
recovering after years of poor performance.
While investors expect some spending to support an
economy that's expected to post its weakest growth in
four years, they will want to see such stimulus is
well-financed.
Growth has been hampered by a chaotic rollout of a goods
and service tax last year and a shock move to ban high
value currency notes in late 2016, which hit tax
revenues and increased the chances the fiscal deficit
shortfall would hit 3.2 percent target for the year to
March.
An expected pickup in growth next fiscal year and state
asset sales estimated to raise 1 trillion rupees ($15.74
billion) should boost tax revenues.
Despite an expected revenue increase, investors don't
believe India will swing to profligacy, with a rally in
oil prices likely to constrain government spending.
India imports 80 percent of its energy requirements, and
the government may need to respond to higher crude
prices like it did in October, by cutting fuel duties.
The risk that such a contingency is needed could keep
the government in check.
"I believe that there is a high chance that fiscal
discipline is more likely to be maintained in this
budget," said Lakshmi Iyer, fixed income head at Kotak
Mutual Fund.