India had targeted a budget deficit of 4.6 percent of gross domestic product for the current fiscal year ending in March and will miss that by a wider margin than expected. Finance Minister Pranab Mukherjee said he now expects a deficit of 5.9 percent of GDP and forecasts it to fall to 5.1 percent in the next fiscal year.
"It's not smacking of confidence," said Andrew Holland, chief executive for investment advisory at Ambit Capital. "The big reforms have to come afterwards. I'm only hoping that will happen."
The benchmark Sensex index closed down 1.2 percent in Mumbai.
The budget, which must be approved by Parliament, also delivered a blow to foreign investors in the form of a new tax liability, retroactive to 1962, on overseas transfers of Indian assets.
The law would make transactions like Vodafone's $11 billion acquisition in 2007 of the Indian telecom assets of Hong Kong's Hutchison Telecommunications taxable. In January, India's Supreme Court ruled that Vodafone is not liable for up to $4.4 billion in back taxes and penalties on that deal.
"It's quite shocking," said Sudhir Kapadia, a partner at Ernst & Young. "They have done it in a manner to essentially nullify the Supreme Court verdict on Vodafone."
GE, SAB Miller, Cadbury, AT&T, Sanofi, and Vedanta are among the companies fighting tax cases in India that could be affected by the change.
Kapadia said that the move could be challenged in court, but in similar cases in the past the Supreme Court has deferred to Parliament.
"Parliament has the right to make the law," he said. "The Supreme Court only interprets it."
Mukherjee pledged to improve the quality of government spending by cutting subsidies to under 2 percent of GDP.
This year, subsidy spending swelled from unexpectedly high global oil prices, which increased the cost of India's fuel and fertilizer subsidies, he said.
Mukherjee said the government hopes to raise Rs.300 billion ($6 billion) from selling stakes in state-run companies next fiscal year. India raised about Rs.140 billion ($2.8 billion) from such asset sales this year, against an initial target of Rs.400 billion ($8 billion).
He also said the government would allow greater foreign investment in India's fund-starved aviation and power sectors, as well as in corporate debt, and doubled its allotment of tax free bonds for infrastructure projects.
Mukherjee sounded an optimistic note on the economy, saying growth will accelerate to 7.6 percent next fiscal year, up from 6.9 percent this year.
Prime Minister Manmohan Singh praised Mukherjee for striking a balance between the need to accelerate growth and control inflation.
"Right now the challenge before the country is to accelerate the tempo of economic growth. At the same time to ensure that we don't not slip on our obligations to moderate the price rise. I do believe that both these tasks the finance minister has tackled and tackled well," he said.
Indian business leaders bemoaned increases of two percentage points in excise duties and service taxes as inflationary and likely to forestall interest rate cuts.
"If the fear of inflation looms large, how will interest rates come down?" said Suketu Shah, joint managing director of Mukand Ltd., a steel company. "If interest rates don't come down, how do you stimulate growth?"
THE ASSOCIATED PRESS