How will India spend its billions?

This report is from this week’s CNBC’s “Inside India” newsletter which brings you timely, insightful news and market commentary on the emerging powerhouse and the big businesses behind its meteoric rise. Like what you see? You can subscribe here.

The fallout from the result of India’s general election will be in full view next week.

Nirmala Sitharaman, India’s finance minister, is set to unveil her seventh budget on Tuesday, which will offer clues about how Prime Minister Narendra Modi’s political party, the BJP, is likely to work with its allies to run a coalition government.

There are high expectations for a “populist” budget since the recent general election results delivered a slimmer than expected win for Modi.

“The upcoming budget is more significant than in previous years, as it will reflect whether the election setback will have any impact on the direction of government policy and priorities,” said Premal Kamdar, head of India equities at UBS Wealth Management, in a research note to clients.

Modi has been forced to work with smaller parties, one of which represents India’s poorest state of Bihar. The demands from the various members of the fragile alliance could mean the government opens the taps on welfare spending. This will likely lead to increased borrowing.

However, analysts at Goldman Sachs believe that’s unlikely to be the case. “We push back against both views,” said Santanu Sengupta, chief India economist at Goldman Sachs.

They suggest that policymakers may be addicted to the growth created from the infrastructure spend seen over the past few years and “may not be willing” to give up on it just yet.

Far from increasing the amount of government borrowing, Sengupta and team are also entertaining the idea that the deficit could actually fall.

There is some evidence to back this view. Over the past four years, borrowing has fallen more than the budget typically targets. Bank of America analysts, who are also open to the idea that the deficit may fall, believe it is “refreshing” to see a finance minister “under-promise, over-deliver.”

The government’s job of balancing the books has also been made much easier by the Reserve Bank of India after it effectively wrote a $25 billion check to the Indian government earlier this year. The central bank had a surplus since it holds over $200 billion worth of U.S. Treasurys and other securities.

Where will the government spend?

Analysts on Wall Street are keenly tracking how the political winds are blowing in New Delhi.

Many see a cut in income taxes as overdue since collections have risen from 2% of GDP before the Covid-19 pandemic, to 3% in 2023. It’s expected to rise to 3.5% in 2025 if left unchecked, according to Goldman Sachs’s estimates.

The biggest beneficiaries of such cuts are likely to be — aside from individuals — companies in the consumer staples sector.

“A tactical opportunity in the consumption space could arise if the government announces any consumption stimulus or increases the tax exemption limits, which can trigger consumption demand,” said UBS’ Kamdar.

Funds such as Columbia India Consumer ETF, which hold stocks targeting consumer spending, are up more than 22% this year on the theme, while the Nifty 50 benchmark index has risen 14% over the same period.

Large-cap stocks that had seemingly fallen asleep have suddenly rallied over the past few months. Hindustan Unilever, the listed subsidiary of U.K.-based multinational Unilever, is one such example that has been touted as a way to trade the Indian budget. The company owns a number of brands in India, such as cleaning agents Cif and Domex, Magnum and Cornetto ice creams, Horlicks drinks, personal care makers Dove, TRESemme, and Vaseline, among others.

“Staples performance could see a further uptick based on the magnitude and mode of Government stimuli for rural India in the budget,” said Macquarie equity strategists led by Adity Suresh in a note to clients last week.

“We believe at current levels, HUVR [Hindustan Unilever] offers a better opportunity to play the potential uptick in rural demand from budget outlays.”

Bank of America’s India economist Aastha Gudwani believes the government will further subsidize health care coverage and manufacturing in the country to shore up jobs.

“To boost consumption, we expect [an] effective tax rate cut, higher subsidy for cooking gas and interest rate subvention for rural and urban housing,” said Gudwani.

“While this may sound like a lot of spending, we don’t see this disturbing overall fiscal math courtesy the bonanza dividend received by the central government from the RBI and other [Central Public Sector Enterprises].”

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IMF forecasts a bumpy GDP ride for India. The International Monetary Fund upgraded its economic forecast for India for 2024 while warning that growth will dip in the following year. India — which the IMF had previously called “the world’s fastest-growing major economy” — is expected to grow 7% in 2024, higher than April’s projection of 6.8%. However, it expects growth to decline and reach 6.5% in 2025.

Indian stocks have hit record highs again. The Nifty 50 index closed above 24,800 points for the first time, heading for a 1.2% gain this week. Information technology stocks — such as LTIMindtree and Infosys —appear to be behind the rally after beating earnings expectations.