FACTBOX - Key political risks to watch in India
NEW DELHI (Reuters) - A weak economy exposed to an extended euro zone crisis, growing strain on the government coalition, and looming state elections that mean progress on tough reforms are unlikely are some of the risks to watch in early 2012 in the world's largest democracy.
RATINGS (Unchanged since January unless stated):
The cost of insuring against default on 5-year sovereign debt traded around 88 basis points at the start of February, down around 20 points from the start of the year.
Following is a summary of key political risks in India:
A feel good rally in Indian markets has given welcome relief to investors after months of gloom that made the currency and the stock market among the world's worst performing last year, but under the surface the problems afflicting Asia's third-largest economy remain largely unabated and unaddressed.
Inflation is down sharply, but almost entirely because of a drop in volatile food prices. And with the government embroiled in political wrangling over corruption scandals and unreliable coalition partners the prospects seem slim for tricky tax reform or a softening of foreign investment rules that could help deal with infrastructure bottlenecks.
The winter session of parliament was an unmitigated disaster from start to finish. As a result of passing no major legislation, the government now has a heavy load of promised reforms to try and push through two fractious houses in the budget session in March. Fickle coalition partners and a disruptive opposition mean the government is often effectively a minority when it tables bills.
Prime Minister Manmohan Singh promises to bring in a stalled policy to allow foreign supermarkets into India by March, along with a corruption ombudsman. The first stage of a new tax system is planned for April. On current form, nobody should hold their breath though.
In December, Goldman Sachs' 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.
Asia's No. 3 economy is sitting on a comfortable cushion of $300 billion in foreign reserves and a confidence-building $15 billion currency swap line with Japan was unveiled in December, so comparisons with India's 1991 payments crisis are premature.
But as ever, India's dependence on imported, then subsidized energy is a weakness, with high prices adding to pressure both on the current account and fiscal deficits. A drawn out crisis in Europe could exacerbate the capital outflows and further moderate exports.
Morgan Stanley wrote in February that the ongoing fiscal and current account deficits will continue to pressure the rupee against the dollar over the long term.
"As the economy undergoes an extensive deleveraging process, we expect Indian equities and credits to underperform against their regional and emerging market peers during 2012," it said.
What to watch:
-- Headline inflation. If price rises show a sustained slowdown, expect the monetary easing India Inc. has been demanding for months.
-- Moves to accelerate project approvals and implementation.
-- The global economy and domestic demand.
ELECTIONS AND POLITICAL WRANGLING
Elections in five states early this year will test support for the ruling Congress party roughly half way through Prime Minister Manmohan Singh's second term. Elections are hard to predict in India, but opinion polls suggest Congress could do better than a year of corruption scandals and disappointing growth would suggest.
A poor result for Congress would compound the feeling that Prime Minister Singh is a lame-duck. Already, and even from within the ruling Congress party, anger at Singh's lacklustre performance is on the rise, with growing talk in the Indian media that he could step aside this year to be replaced by a caretaker until elections.
That is still unlikely and the government could probably also muster the support to survive a no-confidence vote. The government's real saving grace may be the lack of appetite in the opposition Bharatiya Janata Party for an general election before 2014. Despite Singh's woes, it is by no means clear the BJP has won over many voters to its Hindu nationalist cause.
The party could win in farming state Punjab, and in the 200 million people strong Uttar Pradesh, any improvement on the 22 seats it currently holds in the 403 seat state assembly would be spun as a victory.
Rahul Gandhi, son of current party leader Sonia Gandhi, 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.
Even if the party comes in fourth place but forms a coalition government in the state he will be seen as a success.
Party chief Sonia Gandhi, who is at least as influential as the prime minister, has made more public appearances but has shed no light on the illness she is suffering, which some Indian media reports say is cancer.
What to watch:
-- 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.
-- Election results, which will be announced on March 6.
-- Political wrangling around the budget for the 2012/13 fiscal year, likely to be announced after the state election results in early March.
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.
Pakistan's own perilous political situation could have far reaching fallout for relations between the nuclear armed neighbours.
This jostling between China and India 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. 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.
-- Pakistan's domestic problems. The fall of the civilian government there could undo the progress made on normalizing ties in the past year.
(Additional reporting by Rajesh Kumar Singh; Editing by Daniel Magnowski)
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