The budget was already under strain even before this weekend's events in Karnataka -- where PM Modi's Bharatiya Janata Party failed to form a government. The fiscal target was breached in the 2018 financial year, while the goal for this year was widened to 3.3 per cent of gross domestic product.
Add to that a surge in oil prices, the currency's more than 6 per cent slump against the dollar this year, and a pick-up in inflation, and India's outlook is starting to look gloomy.
"The Karnataka election is an additional source of uncertainty," said Suvodeep Rakshit, senior economist at Kotak Institutional Equities in Mumbai. While there's usually a risk of fiscal slippage in the year before elections, the rise in oil prices is worsening the picture, he said, forecasting a budget gap of 3.5 per cent of GDP this year.
Bonds have taken a knock this year, fueled by wider budget targets, faster inflation and a global selloff of emerging market assets. Yields on the 10-year bond have climbed almost 50 basis points since the beginning of the year.
India's rural areas are home to about 68 per cent of the nation's 1.3 billion people, and form a key voting bloc in the world's largest democracy. PM Modi has promised to increase the living standards of villagers and double farmers' income by 2022.
In the past six months, the BJP has faced stiff competition from the opposition Congress Party in pm Modi's home state of Gujarat and in by-elections in Bihar, Rajasthan and Uttar Pradesh. While the BJP won more votes in Karnataka than in the last election, it fell short of an overall majority.
A recent working paper by the Reserve Bank of India shows growth in rural incomes have been decelerating in the past four years. That was partly due to two consecutive droughts in 2014-15 and 2015-16. In addition, the construction industry, which was booming during 2000-2012 and was a major driver of rural non-farm employment, had slowed down.
Economists at Nomura Holdings Inc. wrote in a report last week that they expect the BJP to focus on lifting rural incomes and alleviating farm distress in coming months given upcoming votes in states like Madhya Pradesh and Rajasthan and the 2019 general election.
But authorities have a fine balancing act in boosting spending to farmers, while keeping the budget deficit under control.
"Doubling farmers' income is a big joke. That's not happening," said Ashok Gulati, a professor at the Indian Council for Research on International Economic Relations in New Delhi. "This is bound to have repercussions for the economy."
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