India unveils budget for recovery and the poor after cash crunch

India is a "bright spot" in the world economy, Finance Minister Arun Jaitley said as he unveiled his annual budget on Wednesday, adding the impact on growth from the government's cash crackdown would wear off soon.

 Delivering his fourth budget address to parliament, Jaitley vowed to spend more on rural areas, infrastructure and poverty alleviation in what he called a budget for the poor. Yet he also said the government would pursue prudent fiscal management to preserve India's economic stability.

"We are seen as an engine of global growth," Jaitley said in his opening remarks. But he cautioned that the prospect of US interest rate hikes, rising oil prices and signs that globalisation is in retreat could adversely affect India.

Prime Minister Narendra Modi's surprise decision last November to scrap high-value banknotes worth 86 percent of India's cash in circulation has hit consumer demand, disrupted supply chains and hurt capital investments.

The worst of the cash crunch is now over, however, and Jaitley said he expected it would not have spillover into the fiscal year starting on April 1. A private manufacturing survey on Wednesday showed business was slowly returning to normal.

Still, the finance ministry forecasts that growth could dip to as low as 6.5 per cent in the current fiscal year to March, before picking up slightly in the coming fiscal year to between 6.75 and 7.5 per cent.

That is below the target rate of 8 percent or more that Modi needs to create enough jobs for the 1 million young Indians who enter the workforce in India each year. Half the population in the nation of 1.3 billion is below the age of 25.

While opinions vary on how long the disruptions caused by Modi's crackdown on untaxed and illicit wealth will last, there is near unanimity among economists that Asia's third-largest economy needs a helping hand.

DEFICIT DILEMMA

Arvind Subramanian, Jaitley's chief economic adviser, on Tuesday advocated slashing personal income tax and accelerating cuts in corporate tax rates. He cautioned, however, against pursuing debt-fuelled fiscal expansion.

Economists are pencilling in a federal fiscal deficit of 3.3 per cent of GDP for 2017/18. That would be higher than the 3 percent pledged earlier but lower than 3.5 percent that the government has budgeted for the year soon to end. The rollout of a nationwide Goods and Services tax (GST), expected in July after years of delays, could also weigh on economic growth.

Countries that have introduced GST in the past have often faced a relative economic slowdown before the benefits of a unified tax regime feed through.

Jaitley's fiscal largesse will not only boost consumer spending, but may also shore up the fortunes of Modi's nationalist party in five regional elections for which voting begins on Saturday.

The electoral outcome, particularly in the battleground state of Uttar Pradesh that is home to one in every six Indians, would play a big part in determining whether Modi can win a second term in 2019.

Busting the deficit target, however, would worry ratings agencies at a time when oil prices - India's most costly import - are on an upswing. Standard & Poor's has already warned that, at 68.5 per cent, India's public debt-to-GDP ratio is still too high.

A slowdown in fiscal consolidation would also limit the room for monetary easing. Investors are betting that the Reserve Bank of India would lower its policy rate by another 25 basis points (bps) as early as next Wednesday. The central bank has cut interest rates by 175 bps since January 2015 to 6.25 per cent.