FACTBOX - Key risks to watch in India

NEW DELHI Mon Dec 12, 2011 3:58pm IST

Activists from Bharatiya Janata Party (BJP) hold placards while taking part in a protest against government's decision to allow Foreign Direct Investment (FDI) in the retail sector, in New Delhi November 28, 2011. REUTERS/Parivartan Sharma/Files

Activists from Bharatiya Janata Party (BJP) hold placards while taking part in a protest against government's decision to allow Foreign Direct Investment (FDI) in the retail sector, in New Delhi November 28, 2011.

Credit: Reuters/Parivartan Sharma/Files

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NEW DELHI (Reuters) - Fallout from a botched attempt at retail reform, a weak economy that has some analysts muttering darkly about India's balance of payments, a renewed threat of street protests and looming state elections that mean progress on tough reforms are unlikely, are the major risks to watch as the year ends in the world's largest democracy.

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The cost of insuring against default on 5-year sovereign debt, in common with debt markets elsewhere in the world rose in November then fell to around 100 basis points in December, up 30 since the start of the year.

Following is a summary of key political risks in India:

ECONOMIC MALAISE AND POLICY REVERSAL

A U-turn late in the year on a flagship reform to allow foreign supermarkets to operate in India was a huge blow for the government of Prime Minister Manmohan Singh, who will now struggle to pass serious reforms to attract long-term investment to India as the economy enters choppy waters.

This is all the more worrying as the country's reliance on volatile portfolio flows for foreign investment means it is exposed to the ill health in the global economy. As ever, India's dependence on imported energy is a weakness, one which is being felt in the form of a widening current account deficit.

Like peers Brazil and China, economic growth is slowing and the room for government-led stimulus is limited. In December, the chairman of Goldman Sachs Asset Management, Jim O'Neill, called India the most disappointing of the BRICS countries, and warned of a risk of a balance of payments crisis if policymakers were not careful.

Growth in the second quarter of the 2012 fiscal year fell to 6.9 percent, the lowest rate for more than two years for Asia's third largest economy, while industrial output retreated in October for the first time since 2009.

The rupee is close to record lows, weighed by the surging oil import bill and widening trade deficit, making it the worst performing currency among Asian peers so far this year. India could face a financial crisis if it fails to stem the currency's slide, and the central bank has a difficult choice over how to make best use of its limited reserves to maintain the confidence of foreign investors.

While inflation may finally be easing after a year grazing double-digits, structural factors are likely to keep prices rising at a fast pace in the medium term. With hopes dashed for benefits from global supermarket supply chain expertise, India will have to find new ways to reduce food wastage and increase productivity.

PROTESTS AND PARLIAMENTARY PRESSURE

Prime Minister Manmohan Singh's latest attempt to get his reform agenda back on track blew up in his face, and he looks weaker than ever. There is an outside chance he can push the stalled retail reform through next year, perhaps after key state elections in the most important political state Uttar Pradesh.

A repeat of street protests that rocked the government in the summer are a looming possibility, unless Singh can placate anti-graft leader Anna Hazare by passing suitably tough legislation against graft before parliament closes for the year on Dec 22. The activist is threatening an indefinite hunger strike from December 27 if his demands are not met.

Hazare has also warned he could campaign against the ruling Congress party in key state elections next year, a development that would darken an already cloudy electoral outlook for the government.

With its eye on those elections, which include Uttar Pradesh, Congress hopes to push through bills on mining, land acquisition and food welfare that contain populist measures, but opposition disruption may well slow their passage.

Party chief Sonia Gandhi, who is at least as influential as the prime minister, has shown up in parliament on a number of occasions in recent weeks but has shed no light on illness she is suffering, which some Indian media reports say is cancer.

Her son Rahul Gandhi, the heir apparent to the Gandhi dynasty, has staked his political reputation on getting a good result in Uttar Pradesh, which may be a barometer for the national mood ahead of general elections in 2014.

As a result of the legislative logjam, it is extremely unlikely the government will in the near future be able to introduce a nationwide Goods and Services Tax which would simplify a Byzantine tax code, and raise revenues.

Bucking the trend, the government in October passed a long-awaited policy to spur industrial investment.

What to watch:

-- Street protests around the Lokpal bill to create a anti-graft ombudsman. Political wrangling at the moment is over whether to include low-ranking bureaucrats, the prime minister and the CBI under the Lokpal remit.

-- The Gandhi dynasty. Rahul Gandhi has yet to prove himself as an effective politician, raising concerns he will struggle to lead the party if his mother steps down. The Uttar Pradesh election early next year is a key test.

BETWEEN CHINA AND PAKISTAN

India's foreign policy focus used to be first Pakistan, then China. Now it is more China, then Pakistan. Relations with Islamabad have improved considerably in recent months, with an upgrading of trade ties and an easing of visa regulations helping the thaw.

Still, it would only take one armed attack in India bearing the hallmarks of Pakistani-based militants to reverse the advances. Partly in response to its worries about China's steadily increasing influence among all its neighbours, not least Pakistan, India has forged closer ties with the United States, Australia, Japan and Vietnam.

This jostling between the two Asian giants is not necessarily dangerous and the risks are offset by growing trade and economic relations, but the rivalry will dominate India's policy decisions for years to come.

India is spending heavily on arms to keep pace with China's growing military might, and the two countries still have unresolved border issues. On December 19 India, the United States and Japan will hold their first tri-lateral meeting as Washington pushes ahead with its "pivot" toward Asia, likely to feed into Beijing's concerns of "encirclement" by unfriendly neighbours. India is also stepping up its involvement in Afghanistan, possibly at the behest of Washington, worried about a power vacuum as NATO troops withdraw in the next few years.

What to watch:

-- Development of ties with East Asian nations to counter China, not least in the South China Sea. Australia has mentioned the possibility of a tri-lateral security pact with India and the United States. India says this is not on the cards but is stepping up naval cooperation with Australia.

-- Chinese Premier Wen Jiabao visits Nepal on December 20, the latest expression of Beijing's assertiveness in countries traditionally under India's sphere of influence.

-- India's ties with Afghanistan. Some reports say Delhi will train 20,000 Afghan troops in the next few years, a development that would worry Pakistan.

(Editing by Daniel Magnowski)

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