Anything less than a strong show of deficit-slashing intent in the budget, to be unveiled on Feb. 26, is likely to disappoint investors.
With its economy booming anew, India is well-positioned to wean itself from aggressive deficit spending that risks driving up funding costs, crowding out private borrowing and scaring away overseas investment desperately needed to fund infrastructure.
"If you can't do fiscal consolidation when the economy is strong, when can you do it? This is the time to do it," Stephen Roach, Asia chairman of Morgan Stanley, said recently in Mumbai.
Finance Minister Pranab Mukherjee is widely expected to initiate a gradual pull-back of stimulus measures when he unveils the budget for the next financial year on Feb 26, but will stop short of curtailing spending or borrowing.
Instead, Mukherjee will hope accelerating growth, improved tax receipts and the sale of government assets provide enough new revenue to avoid unpopular spending cuts and yet allow him to lower a deficit poised to hit 6.8 percent of GDP this year, which would be a 16-year high.
Inflation approaching double-digits, meanwhile, is expected to prompt the Reserve Bank to raise interest rates by late April, bringing up borrowing costs and adding pressure to cut the deficit.
New Delhi is on track to borrow a record 4.51 trillion rupees ($98 billion) in the current fiscal year, and market expectations are for higher borrowing in the new year, with a Reuters poll forecasting a 2.2 percent pickup.
India has set a target of cutting its fiscal deficit to 5.5 percent of GDP in the new fiscal year, with analysts polled by Reuters forecasting 5.6 percent. Including state-level shortfalls, the total is now roughly 10 percent.
That is by far the highest among the BRIC group of emerging economic powers. China's fiscal deficit is forecast this year to be 2 percent of GDP, while Brazil's will be 1.1 percent and Russia's 3.2 percent, International Monetary Fund data show.
Missing the deficit target or borrowing more than investors expect would send bond yields higher and convey a negative message to markets choking on government debt.
"The key for this budget is...fiscal deficit and I would say it's not just the next year's target, but the road map going ahead," said A. Prasanna, economist at ICICI Securities Primary Dealership in Mumbai.
"If the government can have a credible plan and they can communicate it, I think that will be the best thing for financial markets," he said.
Asia's third-largest economy is forecast to grow at about 7.5 percent in the fiscal year that ends March 31 and accelerate in the year through March 2011.
Still, Prime Minister Manmohan Singh's government is reluctant to make drastic cuts in support measures when recovery remains uneven, with stimulus accounting for much of the recent rebound. A still-cloudy global outlook adds to the caution.
Politics also constrains the government from making tough choices that would alienate a Congress party voter base that is predominantly rural and poor.
For example, the government is expected only to partially adopt, at most, recent recommendations by a committee to introduce market pricing for gasoline, diesel and cooking fuel.
A surge in global food and energy prices that added to India's subsidy burden would thus pose an added threat to deficit-reduction efforts.
To grow revenue, India may partially reverse cuts in excise taxes put in place to help tide makers of cars, cement and other goods through the downturn, according to Edelweiss Securities.
It will also look to sell off stakes in government companies such as Steel Authority of India Ltd, Coal India and BSNL, which economists expect to fetch roughly $6.5 billion in the new financial year. Success or failure of the sales is a swing factor on the revenue side of the government ledger.
Deepali Bharghava, economist at ING Vysya Bank, expects the deficit to be trimmed to 5.8 percent of GDP, with 11 percent growth in spending and a 15 percent rise in budgeted tax revenue.
"Disinvestment will be very key," she said.
With foreigners the biggest buyers of new Indian shares, a collapse in global risk appetite would undermine stake sale plans, thwarting deficit-cutting efforts.
New Delhi also hopes the delayed sale of 3G mobile licenses brings a few billion dollars into government coffers.
Few major new policy initiatives are expected in the budget, which is a much-anticipated event in India each year.
Mukherjee is likely to unveil a roadmap for implementing a nationwide goods and services tax, which has been delayed beyond its earlier April 1 target start date.
He may also outline further plans for the sale of stakes in government companies and third-generation mobile phone spectrum.
Otherwise, he will probably announce small-bore moves to begin rolling back tax breaks that were part of the stimulus.
Spending programmes, including rural social schemes that sustained demand during the downturn, will remain in place.