Finance Minister Arun Jaitley is likely to stretch the fiscal deficit target to 3.8 per cent of GDP for the next fiscal from the earlier commitment of 3.5 per cent.
"We believe the government, facing mounting spending pressure such as a higher wage bill, may choose to sign up for a wider deficit of 3.8 per cent of GDP," HSBC India Chief Economist Pranjul Bhandari said in a note.
Stating that addressing the worries on growth is possible even if the government sticks to the 3.5 per cent target, she warned that wider fiscal deficit numbers may hurt growth over a longer period as the government's borrowing will crowd out private sector demand.
"The net impact on growth, although positive in the short-term, could be uncertain over time, as a higher fiscal impulse could be met with some degree of crowding out," she said.
She further argued that "a credible discussion on the quality of spending and the future path of consolidation will become critical, especially because the FY18 target of 3 per cent is even more challenging."
All eyes will be on the fiscal gap number which Jaitley spells out in the Budget 2016-17 to be presented on February 29.
In the Budget for 2015-16, Jaitley had stretched the fiscal deficit target to 3.9 per cent from the earlier 3.6 per cent to address growth concerns.
International rating agencies have threatened to downgrade the country's sovereign rating if the government neglects fiscal maths.
To worries about growth suffering if the government sticks to the 3.5 per cent fiscal deficit target, HSBC said fiscal consolidation can co-exist with both macro-stability and higher growth.
"A falling fiscal deficit does not necessarily mean that the landing will be fatal. How you land makes all the difference," it said.
Reserve Bank Governor Raghuram Rajan has been very vocal against any stimulus by way of debt-driven public investments, citing the perils that Brazil has faced since following such a path in the early part of this decade.
Updated Date: Feb 19, 2016 12:43 PM