NEW DELHI/MUMBAI - India's government will not be able to cut its budget deficit this fiscal year as previously projected, officials said, but will seek to cap the shortfall at last year's level to prevent a major deterioration in public finances.
Efforts to maintain some fiscal discipline reflect New Delhi's concern around risks to its sovereign credit rating but will likely limit the government's firepower to contain inflation and provide relief to households and businesses.
In February, Prime Minister Narendra Modi's government set a fiscal deficit target of 6.4% of gross domestic output (GDP) for the year that started on April 1, compared with a deficit of 6.7% last year.
The sources said that while increased spending to provide relief from inflation meant the government would miss this year's target, policymakers would seek to limit the deviation to 30 basis points.
"We will try to contain the slippage to last year's levels," one of the officials, who declined to be identified, told Reuters.
Surging costs forced India in May to cut fuel taxes and change duty structures, hitting revenues by about $19.16 billion, while additional fertiliser subsidies lifted expenditure.
The government and central bank have scrambled to contain prices through fiscal measures and monetary tightening after inflation jumped to multi-year highs.
Retail inflation has held above the Reserve Bank of India's 6% mandated ceiling for five straight months while wholesale price inflation has risen to 30-year highs.
The government is wary of the risks fiscal slippage poses to its sovereign credit ratings. Its debt to GDP ratio, which stands at around 95%, is significantly higher than the 60-70% levels for other, similarly rated economies.
That leaves the government with little room to provide additional relief, as the May measures are already expected to drive up the deficit by more than 30 basis points if revenue collection does not exceed the budget target.
"The government can definitely do more but at what cost? If more steps are taken, it will require additional market borrowing and that will drive up yields and eventually cause higher inflation," said a second source who is aware of the discussions.
The government is reluctant to expand its record market programme of 14.31 trillion rupees this fiscal year, both officials said, adding that a decision on an additional borrowing requirement would only be taken in November.
The benchmark 10-year bond yield rose 1 basis point to touch the day's high of 7.44% following the report, extending its gain to 4 bps on the day.
The finance ministry did not immediately respond to requests for comment.
"From here on, monetary policy will bear the larger burden of initiating inflation-growth corrective balance. The first quarter has been good in terms of tax collection, but alongside the excise cut could neutralise it," said Shubhada Rao, senior economist and founder of QuantEco Research.
"Early days yet to quantify the extent of slippage, if any. The net borrowing is already large, it would be absolutely the last resort to go for additional market borrowing," she added.
The first official said fertiliser subsidy bills could rise by 500 billion to 700 billion rupees from a current estimate of 2.15 trillion rupees. Higher crude oil prices were also adding to the challenges while room for tax cuts was limited.
"We are aware that we may have to prepare ourselves for more measures but that may mean bringing down other growth focussed expenditures," he added.
The second official said that with little scope for more central government measures, state governments needed to do more to help control inflation.
Tax collection remains the "bright spot" and had given the government some room to manoeuvre, the first official said.
From April to June 16, direct tax collection rose 45% year-on-year to 3.4 trillion rupees, while indirect tax collection in April-May rose nearly 30%.
(Reporting by Aftab Ahmed and Swati Bhat; Editing by Sam Holmes, Robert Birsel)