Key risks to watch out in India

NEW DELHI Tue Apr 3, 2012 1:09pm IST

1 of 5. Labourers carry coal at a stockyard of an underground coal mine in the Mahanadi coal fields at Dera, near Talcher town in Orissa March 28, 2012.

Credit: Reuters/Rupak De Chowdhuri

NEW DELHI (Reuters) - India's economy is exposed to an extended euro zone crisis and policy paralysis at home, while the coalition government is under tremendous strain from scandals and rebellious coalition partners.

The risk of Prime Minister Manmohan Singh's second term being cut short before a general election due in 2014 is low, but cannot be ruled out.

The failure of Congress party in state elections in early March, and a looming fight over the cheap sale of coalfields have put him and the party under even more pressure.

The 2012/13 budget, delivered in March, shied away from commitments to bold reform, its cautious tone reflecting the government's frailty.

RATINGS (Unchanged since March unless stated):

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The cost of insuring against default on 5-year sovereign debt traded at 83 basis points in mid-March, down around 25 points from the start of the year.

Following is a summary of key political risks in India:

SCANDALS, ELECTORAL FAILURE

Lurching from crisis to crisis for more than a year, Prime Minister Singh's government has a new front to deal with in the form of a looming fight over the low-priced sales of coalfields in his first term. A draft report by the Comptroller and Auditor General of India leaked to a newspaper estimated lost revenue of $211 billion from the sales, but the CAG has since backed away from that number.

All parties will now wait for the final report to be tabled in parliament, when the government will once again be put under severe pressure.

Rahul Gandhi, son of current party leader Sonia Gandhi, utterly failed to deliver a promised comeback for the Congress party in crucial state elections in early March, casting fresh doubt on his capacity to become the next member of a dynasty to lead the country.

The party's flop in Uttar Pradesh has reduced Singh's scope to re-launch reforms and reverse a slowdown in economic growth.

Anger at Singh's poor performance is rising, with some talk in the Indian media that he will not survive as prime minister until 2014 elections.

That is unlikely, and the government could probably also muster the support to survive a no-confidence vote. Also helping the government is the lack of appetite among the opposition Bharatiya Janata Party (BJP) for a general election before 2014. Despite Singh's woes, it is by no means clear the BJP has won over sufficient voters to its Hindu nationalist cause.

Party chief Sonia Gandhi, who is at least as influential as the prime minister, has made more public appearances of late, but shed no light on her illness, which some Indian media reports say is cancer.

What to watch:

- CAG's report on coal, which has the potential to be even bigger than the telecoms scandal that rocked the government last year. No evidence of wrongdoing has yet emerged.

- The Gandhi dynasty. Rahul Gandhi has yet to prove himself an effective politician, raising concerns he will struggle to lead the party if his mother steps down.

ECONOMIC MALAISE, BUDGET FAILS TO INSPIRE

The stock market fell in response to Finance Minister Pranab Mukerjee's annual budget on March 16, seen as a weak attempt at tackling the fiscal deficit, the worst among the big emerging market BRIC nations.

Mukherjee unveiled a smattering of anti-deficit measures including an increase in services and excise taxes, but dared not cut subsidies for petroleum products, which have weighed heavily on government finances especially as oil prices stay high.

Some analysts believe the government may miss its newly-set target of cutting subsidy spending to 2 percent of GDP, as well as a goal of cutting the fiscal deficit to 5.1 percent from 5.9 percent in 2011-12.

In the main, the problems afflicting Asia's third-largest economy remain unsolved.

Inflation is down sharply, but almost entirely because of a drop in volatile food prices. With the government embroiled in corruption scandals, and dealing with 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.

An early 2012 Supreme Court order that 122 telcoms licences be revoked was deeply embarrassing for the government, and Singh has had to roll back even modest economic measures like a railway fare rise.

The government has succeeded in passing no major legislation, leaving it with a heavy load of promised reforms to push through two fractious houses of parliament. Fickle coalition partners and a disruptive opposition mean the government is often effectively a minority when it tables bills.

Singh has promised to revive a stalled policy to allow foreign supermarkets into India, 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.

India 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.

As ever, India's dependence on imported, subsidised energy is a weakness, with high prices adding to pressure both on the current account and fiscal deficits. A long financial crisis in Europe could exacerbate capital outflows and further trim demand for Indian exports.

What to watch:

- Response to the budget, both political and economic. Moody's Investors Service said the budget was "credit negative" and lacked new solutions to address India's fiscal constraints.

- Headline inflation. If price rises show a sustained slowdown, expect the monetary easing India Inc. has been demanding for months.

- Oil prices, the global economy and domestic demand.

(Editing by Daniel Magnowski)

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