Mumbai: Leading American brokerage Goldman Sachs has said the forthcoming Union Budget will be keenly watched as a "test of the government's commitment" to fiscal responsibility.
"The budget will be keenly watched as a test of the government's commitment to fiscal responsibility, whether there is a credible plan for reducing the fiscal deficit and whether populist measures can be avoided before the 2014 general elections," the Wall Street firm said in a note.
From a stock market perspective, the report also says the budget could be positive for banks, capital goods and logistics, but negative for consumer goods.
It further said that while Finance Minister P Chidambaram is likely to announce a deficit target of 4.8 percent for FY14, the credibility on how to achieve this target will be the key.
Chidambaram has already cut down on planned expenditure by up to 10 percent and has publicly stated that he would bring fiscal deficit down to 5.3 percent this financial year.
"We think the budget will focus on expenditure cuts, which have a better chance of succeeding, rather than optimistic revenue increases.
"In terms of financing the deficit, our analysis of demand for government bonds suggests that the Reserve Bank is likely to do fewer OMOs compared to the previous years, due to increasing demand from banks and mutual funds," Goldman Sachs India chief economist Tushar Poddar said in the report.
Explaining their rationale, the report prepared by Poddar said, the very high fiscal deficit is endangering macro stability and contributing in part to a high current account deficit. To ensure a stable macro environment, reducing the fiscal deficit is necessary, albeit not sufficient.
"Secondly, after several years of running high deficits and missing targets, there is a high degree of market scepticism. On the other hand, expectations have been raised by the Finance Minister's recent investor roadshows promising credible fiscal consolidation," the report said.
The report further said the sense is that market views appear to be moving in a more positive direction regarding the Budget.
"Thirdly, in the midst of a sharp deceleration in growth in 2012 (pegged at 5 percent or a tad above), the composition of fiscal reduction will be important, in whether it further reduces growth by cutting much-needed capital spending or by reducing wasteful subsidies, which can boost medium term growth potential.
"Finally, in an election year, there is a tendency for populist measures. Markets will be watching closely for such steps and their potential to undermine the needed fiscal discipline. We preview the Budget and answer key questions related to it," Poddar said.
It also said as a result, the bond yields are likely to trend down going forward.
However, the report said: "The fiscal consolidation we envisage will likely have a negative impact on aggregate demand. Our fiscal impulse indicator suggests a negative impulse of 0.5 percent of GDP to demand in FY14. However, we think this would be mitigated somewhat by lower sovereign risk and bond yields."
"We also expect the government to budget for a marginal increase in tax revenues on the back of a gradual pickup in economic activity. We think there will likely be some cuts in defence and welfare spending, while attempting to protect capital spending, so as not to jeopardise a growth recovery," said the report.