India Weighs Budget Cuts Amid Rising Oil Prices and Subsidy Costs

India's government is weighing spending cuts across parts of the budget as higher oil prices inflate subsidy bills and threaten to derail its fiscal consolidation plans, according to officials familiar with the matter.

The options have been reviewed in meetings with Finance Minister Nirmala Sitharaman over the past month, although no decision has yet been made, the officials said, asking not to be identified because the discussions are private.

There’s little appetite to reduce the budget on capital expenditure or defense, they said. Officials are instead reviewing other areas where spending could be trimmed, such as allocations for water resources and loans to states.

A spokesperson for India’s Finance Ministry didn’t respond to a request for comment.

Prime Minister Narendra Modi’s government is facing mounting economic challenges as the Middle East conflict drags on. Oil import bills have surged, the currency has plunged to a record low, and inflation threatens to exceed the central bank’s 4% target.

Economists warn that elevated oil prices could jeopardize the government’s goal of narrowing the fiscal deficit to 4.3% of gross domestic product in the year ending March 2027, potentially resulting in the first fiscal slippage since the pandemic.

Data last week showed the fiscal deficit nearly doubled from a year earlier to 3.6 trillion rupees ($37.8 billion) in April, the first month of the financial year, as spending far outpaced revenue receipts.

A widening budget deficit would require the government to raise revenue elsewhere or borrow more. The government is wary of increasing borrowing beyond budgeted levels because additional debt issuance could push bond yields higher, officials familiar with the matter said.

India has budgeted 1.71 trillion rupees for fertilizer subsidies this fiscal year, but officials estimate the bill could almost double if global energy prices remain elevated. At the same time, a smaller-than-expected dividend payout from the central bank has left the government with limited fiscal buffers to absorb the additional costs.

Any decision to prune spending could be politically tough for Modi as it risks hurting the government’s key welfare programs for rural areas. Reducing funds to states could also turn into a political flashpoint. Many opposition-ruled states in the south have previously raised concerns over what they say is the unfair sharing of tax revenue from the federal government, limiting their ability to spend on roads, ports and highways.

For now, the deliberations remain at an early stage, with officials expected to re-assess the situation in the second-half of the year, the people said. Even if spending reductions are eventually implemented, the people said it may not be enough to keep the deficit in check if oil remains around current levels.

The government has already announced a series of measures aimed at stemming foreign outflows, supporting the rupee and attracting foreign capital, while the Reserve Bank of India has sought to bolster its foreign-exchange buffers amid sustained market volatility.