Key political risks to watch in India

NEW DELHI Wed Jun 1, 2011 1:20pm IST

Prime Minister Manmohan Singh attends the Indian labour conference in New Delhi November 23, 2010. REUTERS/B Mathur/Files

Prime Minister Manmohan Singh attends the Indian labour conference in New Delhi November 23, 2010.

Credit: Reuters/B Mathur/Files

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NEW DELHI (Reuters) - After state elections in May in which the ruling Congress party and its allies performed well, Prime Minister Manmohan Singh will start work on reshuffling his cabinet and raising fuel prices before the next parliamentary session in July.

There is little sign, however, that major reforms such as freeing diesel prices or allowing foreign investment in the retail sector will be pushed forward, given high inflation and the government's continued lack of political authority due to wide-ranging corruption scandals.

CABINET RESHUFFLE AND COALITION TIES

Singh has said he plans to reshuffle his ministers soon, and the cabinet's new composition will provide an insight into thinking on reforms within the party and the government.

Appointing younger, more pro-reform ministers, and axing non-performing ones, would send a sign that Singh is serious about change, but the need to shore up his own position makes this unlikely. Coalition ties, and the desire to gain allies ahead of more state polls next year, will frame the new team.

Finance Minister Pranab Mukherjee, Home Minister Palaniappan Chidambaram and Defence Minister A.K. Antony are likely to keep their jobs.

The foreign ministry, presently headed by the lacklustre S.M. Krishna, Anand Sharma's trade ministry and maverick Jairam Ramesh's environment ministry will be most keenly watched in the reshuffle.

Congress is unlikely to overhaul any of the ministries that its coalition partners hold, including the railways ministry, left vacant after Mamata Banerjee resigned to become chief minister of West Bengal.

Congress' coalition partners will continue to try to keep the government from painful economic reforms such as raising fuel prices, but no party is expected to pull out and force early elections.

What to watch:

-- Changes made in the cabinet reshuffle, especially in the environment, foreign and trade ministry.

CORRUPTION

Several graft scandals in Singh's second term have diverted the government's energies from policymaking, which has drifted into limbo. They have also caused rifts within the coalition and given the opposition ammunition to hit at Congress.

The CBI have arrested Kanimozhi, Rajya Sabha MP and daughter of DMK chief M. Karunanidhi, the Congress' second largest ally, in the telecoms-graft case, the biggest in India's history. That has strained ties but it is not likely to force the DMK to exit.

Kanimozhi's arrest followed the arrest of Andimuthu Raja, a DMK member who was telecoms minister during the flawed 2007-08 issue of mobile phone licences, which could have lost India $39 billion in potential revenue.

Long-term investors have so far shrugged off the scandals as part of the risks in an emerging economy, but the worries have weighed on the Mumbai stock market, one the world's worst performers this year.

What to watch:

-- Investigations into the graft cases and high profile arrests.

-- Court proceedings in the cases.

INFLATION

India is still unable to get a grip on high prices despite nine rate hikes since March 2010. Few expect inflation to ease quickly, raising the risk of heightened public anger.

Prolonged high prices will only increase the probability the government will slip into costly populist measures and slow down on painful reforms, putting at risk plans to rein in the fiscal deficit to 4.6 percent of 2011/12 GDP.

It is unlikely the government will remove controls on diesel prices and allow full market pricing of other fuels.

The RBI has said it is willing to sacrifice some short-term growth to cool prices, and markets expect it to continue tightening monetary policy.

Wholesale price inflation, the main gauge of prices in India, eased to 8.43 percent in April, but remained above the RBI's comfort level of around 5 percent.

The risk is that too-tight monetary policy could affect growth in Asia's third largest economy, and slow down expansion to below the forecast 8.5 percent.

What to watch:

-- Statements from officials, advisers and central bankers on inflation and policy responses.

-- Government data on inflation and output.

-- Domestic protests over high prices.

-- Oil prices. Higher crude prices will mean a larger subsidy bill as well as greater inflationary pressures.

REGULATORY RISK

Investors are watching the telecoms ministry as it considers revoking several mobile phone licences, a decision that could raise questions about the reliability of government contracts in India.

An adverse decision for firms could affect foreign investment into India, especially in the telecoms market which is the world's second largest and fastest growing.

The ministry had asked five firms, including the Indian units of Telenor and Etisalat, to respond to CAG's charges they were not eligible for the licences issued in 2008. All firms have defended their licences.

The Supreme Court is also hearing a case seeking the cancellation of these licences for similar reasons.

What to watch:

-- Statements from the telecoms ministry.

-- Court proceedings in the licences case.

DIPLOMACY AND SECURITY

The killing of Osama bin Laden in Pakistan and the testimony of David Headley in a Chicago trial that links Islamabad to the 2008 Mumbai attacks have clouded a fledgling peace process between nuclear-armed India and Pakistan.

New Delhi has said the events support its conviction that Pakistan supports militant attacks against India, and no peace is possible until this ends.

The two nations are trying to revive a peace dialogue that was stalled after the Mumbai attacks, but talks in late May on demilitarising the Siachen glacier failed to make progress, showing how far apart they are even on less contentious matters.

Ministerial talks about Kashmir and efforts to clamp down on terrorism are due in July.

Peace on Pakistan's eastern border with India could make Islamabad more amenable to the idea of moving troops to the western frontier and aid Washington's battle against Islamist groups in Afghanistan.

A truce is also key for India's efforts to calm separatist protests in Kashmir.

What to watch:

-- Comments from policymakers and diplomats.

-- Security warnings of possible militant attacks, which could freeze the dialogues.

(Editing by Daniel Magnowski)

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