Finance Minister Jaswant Singh will walk a fine line between economic and political priorities next week when he unveils a Budget that could begin urgently needed tax reforms in Asia's third-largest economy.

With the ruling nationalist Bharatiya Janata Party facing national polls in 2004 and a spate of state elections ahead of them, analysts say Singh is likely to steer clear of a radical overhaul of India's tax system, where evasion is rampant.

"I expect only politically palatable recommendations to be accepted," said Anirudha Dutta, analyst at ASK-Raymond James.

But analysts say that, while shying away from tough decisions, the budget could set the tone for later and more far-reaching changes to the Byzantine tax structure. Ratings agencies say such changes are key to improving public finances and lifting flagging growth.

"I see some movement forward on taxation reforms and an increased emphasis on compliance," said Anushree Sinha, principal economist at National Council for Applied Economic Research.

The spur has come from a panel headed by former International Monetary Fund executive director Vijay Kelkar, whose master plan calls for simplifying the tax structure, widening the net -- only 25 million of the one billion population pay tax -- and improving collection.

Economists say change is needed to boost revenues to close a combined fiscal deficit of 10 per cent of the gross domestic product, one of the world's highest, and lift tax to 14 per cent of GDP, which would still be far less than the 21.3 per cent of South Korea, Asia's next largest economy.

"Revenues could be increased by expanding the tax base, minimising tax exemptions and improving tax administration," Fitch ratings agency said in a report this month.

India's high debt has kept its sovereign rating at junk levels and curbed the inflow of vital foreign capital.

Fitch said interest costs represented 50 per cent of revenues and were holding back government capital spending, curbing growth.

Growth is officially estimated at 4.4 per cent for 2002/03 (April-March), down from 5.6 last year, due to a devastating drought that hit agriculture. The expansion is way below the eight to 10 per cent level needed to dent widespread poverty.

Political landmine

With a slew of state elections this year in what is seen as dress rehearsal for 2004's general elections, politically hot proposals such as taxing farm incomes and ending tax breaks on housing loans are certain to be shelved, analysts say.

"The (Kelkar) report is a roadmap to tax reforms but there are many political landmines on the route," said Singapore-based P.K. Basu, chief economist for Asia with Credit Suisse First Boston.

But Singh might provide balm to stock markets by granting tax exemptions on capital market income that could help lure back small investors to domestic bourses, which have lost more than $8 billion in market capitalisation since the start of 2003.

"The case for removing the dividend tax has become stronger after the Kelkar committee recommended it and after a similar proposal was made in the US," said Ramdeo Agrawal, managing director at brokerage Motilal Oswal Securities.

"And removal of capital gains tax will make the market more attractive and make the privatisation process easier," he said.

The budget could also bring more services under the tax net to widen the taxpayer base. "Services account for nearly half the GDP but contribute to a mere 2.0-2.5 per cent of taxes collected," said ASK-Raymond analyst Dutta. "It doesn't stack up."

Services, the economic motor for the past decade, remains the fastest growing sector. Official estimates put its growth in the financial year to March at seven per cent, up from last year's 6.7 per cent. That compares with estimated 6.1 per cent growth for the industrial sector and a 3.1 per cent fall in farm output.

India has already made some moves toward tax reform with the planned introduction in April of a value-added-tax (VAT) that will simplify the current multi-tier taxation system that often leads to revenue losses and tax evasion.

"A comprehensive VAT system...will enhance the tax base and energise the economy," said tax consultant Sailesh Haribhakti.

Run-up to the Budget 2003