July 3 (Bloomberg) -- India’s Finance Minister Pranab Mukherjee may increase spending on power, roads and aid to the poor in next week’s budget to bolster growth in Asia’s third- largest economy.

Prime Minister Manmohan Singh will probably back a wider budget deficit for a second year to reward voters who in May handed him the biggest election win in two decades. Goldman Sachs Group Inc. estimates the gap to rise to 6.5 percent of gross domestic product this year from 6.2 percent.

Mukherjee’s budget statement will also serve as the government’s economic agenda for the next five years, spelling out spending priorities, changes in indirect taxes and plans to ease foreign investment rules. He may also lay out a road map to trim the budget shortfall to avert a credit-rating downgrade.

“The budget will be important in gauging the new government’s policy stance,” said Tushar Poddar, an economist at Goldman Sachs in Mumbai. “The deficit can be financed comfortably -- we were more concerned about it before the elections than after.”

Mukherjee will deliver the budget for the year to March 2010 at 11 a.m. in parliament in New Delhi on July 6. The 73- year-old politician, who ran a closed economy as the finance minister in Indira Gandhi’s cabinet from 1982 to 1984, returned to the ministry this year after serving as the defense and foreign minister during the bulk of Singh’s first five-year term.

Election Victory

He said last month the government’s main challenge is to “bring back the economy to a higher growth trajectory without fiscal profligacy.”

Mukherjee has a chance to do that because of the election verdict. His Congress party won the most number of seats since 1991, reducing its dependence on allies such as the communist parties who had blocked the sale of state-run companies, a key source of revenue to fund the budget.

Morgan Stanley economist Chetan Ahya says the government could raise as much as $5 billion this year from sale of stakes in companies, and about $50 billion in its five-year term. India planned to spend 9.53 trillion rupees ($199 billion) in the current financial year, according to the government’s interim budget in February.

The government may also gain more than 242 billion rupees from the sale of third-generation mobile telephone licenses, the Financial Times reported June 21, citing people familiar with the matter.

‘Watch Closely’

India’s budget deficit widened as the government announced election handouts and fiscal stimulus plans to revive the economy. The $1.2 trillion economy grew 6.7 percent in the year ended March 31, the slowest pace since 2003.

“Rating agencies are likely to watch closely the government’s intentions to cut the deficit,” Ahya said. “Any downgrade would adversely affect the outlook for foreign investments into the country.”

The key Sensitive stock index has risen 21 percent since Singh’s electoral triumph on May 16, on optimism the verdict will enable him to take steps to expand the economy. Benchmark bond yields gained 50 basis points to 6.43 percent during the period on concern of higher government borrowings.

India may raise its annual bond-sale target by 10 percent to a record in next week’s budget to fund a widening deficit, a Bloomberg News survey showed. Borrowing in the year ending March 31 may increase to 4 trillion rupees from a previous estimate of 3.62 trillion rupees, according to the median forecast in a survey of 17 economists and investors.

Rating Concern

Moody’s Investors Service places India’s long-term local currency rating at Ba2, two levels below investment grade. Standard & Poor’s and Fitch Ratings have a BBB- long-term rating on India, their lowest investment-grade level.

“The sustainability of India’s public finances is a major sovereign rating concern,” Fitch said in a report on June 30. “India’s Congress Party’s decisive mandate in the recently concluded elections perhaps allows it more meaningful progress on improvements in public finances.”

Among the first indications of Singh’s resolve to tighten finances came on July 1, when the government raised retail prices of gasoline and diesel to cut fuel subsidy costs and narrow revenue losses at state-run refiners.

That also gives Mukherjee money to provide rice and wheat at a subsidized rate of 3 rupees a kilogram as promised during the elections. He may raise wages under the National Rural Employment Guarantee Act, which provides 100 days of work in a year to one member from a poor family.

Ports, Roads

Mukherjee may allocate more to increase capacities in ports, power, roads and other infrastructure, where inadequacies shaves about two percentage points off India’s growth rate, according to the finance ministry. Morgan Stanley’s Ahya expects the government spending on infrastructure to be 6.5 percent of GDP in the next 12 months from about 6 percent currently.

Sajjan Jindal, managing director of JSW Steel Ltd., India’s third-biggest producer, said the government should consider giving infrastructure projects exemption from excise, value- added and sales tax.

Any kind of tax rate cut will be unlikely, given the “weakness” in the budget deficit, said Rajeev Malik, a Singapore-based economist at Macquarie Group Ltd. He said the service tax rate may be raised to 11 percent from 10 percent.

Mukherjee may announce plans to introduce a Goods and Service Tax from April 1, which will subsume all indirect taxes and will levy only value-added production so that manufacturers do not pay taxes twice.

Goldman Sachs’ Poddar expects Mukherjee to also reiterate plans to raise the foreign direct investment ceiling in insurance companies to 49 percent from 26 percent and allow overseas universities to operate in India.

To contact the reporter on this story: Cherian Thomas in New Delhi at Cthomas1@bloomberg.net.

Last Updated: July 2, 2009 23:06 EDT