Key political risks to watch in India

NEW DELHI Mon Jul 2, 2012 4:06pm IST

Former Finance Minister Pranab Mukherjee gestures to photographers as Chief of ruling Congress party Sonia Gandhi (C) and Prime Minister Manmohan Singh (in blue turban) watch at the parliament in New Delhi June 28, 2012. REUTERS/B Mathur

Former Finance Minister Pranab Mukherjee gestures to photographers as Chief of ruling Congress party Sonia Gandhi (C) and Prime Minister Manmohan Singh (in blue turban) watch at the parliament in New Delhi June 28, 2012.

Credit: Reuters/B Mathur

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NEW DELHI (Reuters) - India is going through its worst patch of economic growth in nine years, which has seen the rupee slide to record lows against the dollar and investors clamouring for greater policy action from Prime Minister Manmohan Singh's government.

Amid the slowdown comes a change of guard at the finance ministry, with Pranab Mukherjee resigning on June 26 to run for president. Singh has taken charge of the portfolio, raising investor hopes he will push through long-pending reforms to prop up India's flagging economy.

Less than 24 hours after taking over in a caretaker role, Singh gave a rallying call to his officials to revive the "animal spirit" of the economy with investor-friendly policies.

Singh is under pressure to act fast. India's fiscal and trade deficits have widened, inflation remains too high and Standard & Poor's and Fitch have cut the country's credit rating outlook to negative.

Amid the slowdown,The Reserve Bank of India disappointed many investors when it defied expectations of a rate cut at its policy meeting on June 18, warning that relaxing policy could worsen inflation. That in turn has put the ball back in the government's court to drive growth.

Following is a summary of key political risks in India:

STUTTERING REFORM AGENDA

India's economic growth has slowed sharply, sliding to 5.3 percent in the first three months of this year compared to 9.2 percent in the same quarter of 2011.

As much as the current global financial turbulence, investors blame a lack of significant policy reforms in the eight years of Singh's government, and its unwillingness to curb popular but costly subsidies, for the slowdown.

Once trumpeted as a bold reformer who unshackled the economy from its throttling system of permits and quotas, there are signs that Singh may try to speed up key policies such as opening India's retail sector to foreign supermarkets such as Wal-Mart (WMT.N).

IKEA, the world's largest furniture maker, announced a 1.5 billion euro investment in India on June 22, sending a positive signal of investors' faith in the underlying India growth story.

While supermarket reform has seen many false dawns, the spectre of a ratings downgrade and the need for India to attract foreign capital and revive investor confidence could push the government to act, despite stiff political opposition to change.

Mounting concerns over India's finances may also force the government to finally raise diesel and other subsidised fuel prices after presidential elections on July 19, but such a move remains politically dangerous. Opposition parties would likely organise nationwide protests and strikes. Economists say the government's top priority must be cutting its fuel subsidy bill.

Singh told the G20 summit in Mexico that his government was committed to making tough decisions on controlling fuel subsidies, but sceptics remain doubtful.

With major state elections due to start later this year, and national elections due by 2014, there is a shrinking window for him to make his mark. Other promised changes, such as tax reforms aimed at cutting business costs, have stalled for years because of a lack of political consensus.

There is uncertainty over how Singh will juggle his two demanding day jobs of prime minister and caretaker finance minister, but the absence of a full-time finance minister may further slow the decision-making process.

What to watch:

- Signs of progress on key reform legislation, which could spark a major backlash, including street protests, from opposition parties as well as allies within the government.

- More of the same weak economic data. Headline inflation sped up to 7.55 percent in May, exports have slumped and industrial output is almost stagnant.

- Ratings agencies acting on their threat of a downgrade.

SHIFTING POLITICAL SANDS

The presidential elections have put further strain on the already fractured ties between Singh's ruling Congress party and its most powerful ally. The Trinamool Congress party (TMC) has blocked several big-ticket reforms and tussled with New Delhi over easing the debt burden of its home state of West Bengal.

In what was seen as an open provocation, Mamata Banerjee, the TMC chief, refused to back Pranab Mukherjee's candidacy as president. There is much speculation that she may leave or be ejected from the coalition government, or try to force early elections, though there is no sign yet of that happening.

As things stand, it is unlikely that India will go to the polls before 2014. The government would probably be able to withstand a confidence vote, and India's main opposition Bharatiya Janata Party (BJP), which has been hit by internal squabbles, has shown little appetite for an early vote.

In theory, Banerjee's exit could give Singh more room to implement key policies that she vetoed, such as on retail reform. Her departure would also open the door for the Samajwadi party (SP), which rules India's most populous state and backed Mukherjee's candidacy, to prop up Singh's government.

Mulayam Singh Yadav, the Samajwadi party chief, has signalled he would not let the government fall over retail reform, support that could help blunt the backlash that will ensue if Singh revives the policy in the coming months.

Mukherjee's departure has also prompted talk of a major cabinet reshuffle. Singh is expected to be caretaker finance minister until September, with several names emerging as a possible replacement.

Anand Sharma, the trade minister, has been suggested, and Rural Development Minister Jairam Ramesh has made it known that he is keen on the job. The prime minister is understood to favour close aide Montek Singh Ahluwalia, but as a technocrat he is seen as having little chance and the job is likely to go to a Congress party politician.

What to watch

- Signs that Banerjee could pull out of the coalition.

- Jockeying for position by finance minister aspirants.

- Who is finally chosen as finance minister - will the successful candidate be closer to Singh or party leader Sonia Gandhi, who favours costly pro-poor economic policies? (Editing by Ross Colvin and Daniel Magnowski)

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