New Delhi, February 22

A $16 billion pay rise for India’s public servants and costly food and farm programmes could force the country’s finance minister to cut capital spending in its annual budget, officials and economists say.

The spending pressure on Finance Minister Arun Jaitley threatens to worsen imbalances in India’s $2 trillion economy as consumption outpaces investment, undermining PM Narendra Modi’s promise of better jobs for 1.3 billion people.

A populist budget, ahead of assembly elections in four states this year, could stoke inflation even as structural measures such as Modi’s proposed tax and labour reforms look less likely.

It could also eat into capital spending needed for railways, roads, ports and power projects, seen as vital to India’s integration into the global economy.

“It is not going to be a revolutionary or inspirational (budget) ... given the spending pressures,” said Shilan Shah at Capital Economics. “It is most likely to lead to a sell-off in bond market if the salary hike is implemented.”

Jaitley presents his third budget on February 29 and is expected to implement recommendations of a government commission to raise pay for 10 million federal workers and pensioners by 23.5 per cent.

While that hike would boost demand, economists question whether a policy dating back to an era of double-digit inflation is justified today, when Reserve Bank of India Governor Raghuram Rajan has driven consumer price growth below six per cent. Officials with direct knowledge of budget discussions said Jaitley could raise taxes on services and petroleum products to help cover the extra outlays.

He would still have some room to ease tax rules on foreign investment and hit his deficit target of 3.5 per cent of gross domestic product in 2016-17 fiscal year. The promised pay hike, an increase in food subsidies and a new crop insurance scheme for farmers would cost at least INR 1.2 trillion ($17.5 billion) — equivalent to 0.9 per cent of forecast GDP in 2015-16.