Key political risks to watch in India


Reuters | Thu Jul 1, 2010 | 12:43pm IST

Fuel price hike The government has failed to deliver the reforms foreign investors had hoped for following its re-election last year, but its decision in June to cut costly fuel subsidies is its boldest economic policy move so far. Following is a summary of key risks to watch:

ECONOMIC REFORM

While the Congress-led government had appeared to be in a strong position to press forward with an ambitious economic reform agenda after winning a strengthened mandate in elections last year, progress has been much slower than some investors had hoped. The government has made headway in some areas: it has pledged to reform tax laws, sell stakes in some 60 state-run firms and formed an experts panel to ease foreign investment in the financial sector. June’s decision to free up fuel prices was also a signal the government may be getting more serious about reform. But political expediency in a coalition that smaller parties suspicious of reform will determine the fate of contentious proposals like allowing greater foreign stakes in the pensions and insurance sectors and foreign entry into the retail sector.

What to watch:

  • After the fuel price hike, any signs the government will fast-track other reforms will be bullish for markets.
  • Announcement of stake sales in state firms to raise 400 billion rupees ($8.64 billion) to help cut the fiscal deficit.
  • Progress of a nuclear liability bill which would open up India’s lucrative nuclear power market.

POLITICAL FALLOUT FROM FUEL PRICE REFORMS

Expect noisy opposition protests over the fuel price hikes. The main opposition Bharatiya Janata Party has called a national strike on July 5 to protest the move policy. Opposition parties will also probably try to block legislation in 

the next parliament session by seeking to win over parties allied to Congress. But political pressure is unlikely to lead to a rollback in fuel pricing policy and Prime Minister Manhoman Singh sent a strong signal by saying diesel prices will also be freed. Congress could be hit in major state elections in early 2011, including West Bengal and Tamil Nadu. But these elections remain months away and any voter backlash could be mitigated by using savings from fuel price deregulation to boost social spending.

What to watch:

  • The stance of Congress allies. Two of them face elections in their stronghold states and political expediency may force them to distance themselves from painful reforms which could anger voters. But they are unlikely to bring down the government.
  • The next parliamentary session begins at the end of July and there are several reforms bills pending. Protests over fuel prices could delay the passage of these reform measures.

INFLATION AND MONETARY POLICY

At about 10 percent, inflation is a worry for the government. Market-driven pricing of gasoline and the increase in prices of state-subsidized diesel, kerosene and cooking gas could help reduce the fiscal deficit from the projected 5.5 percent of 2010/11 GDP but will also accelerate inflation and raise the prospect of an interest rate increase. The finance ministry’s chief economic adviser, Kaushik Basu, said fuel price reform would increase headline inflation by 0.9 percentage points. Markets have already priced in a 25 basis points hike in key rates in the central bank’s July 27 policy review. However, because of increasing inflationary pressures, there is the possibility of tougher action. Some traders expect an inter-meeting rate hike of 25 basis points, with another 25 basis points at the policy review. Others expect a rate increase of 50 basis points at the review.

What to watch:

  • Comments of policymakers, advisers and central bankers on the outlook for inflation are to be watched. Hawkish comments raise the likelihood of a rate increase and would weigh on bond prices.

MONSOON

The monsoon, which accounts for 75-90 percent of the rainfall in most parts of India, has hit the southern coast. Good rainfall after last year’s drought would help boost output of grain and oilseeds, calm inflation that triggered street protests, and prompt the government to relax curbs on export of wheat and rice. Any sign of a poor monsoon would push up domestic and global prices of grains, sugar, oilseeds and lentils. It would also add to pressure on the central bank to further tighten policy. Monsoon rains are late in the main sugar and rice producing regions and are unlikely to revive in the next few days. But they are expected to cover the country on schedule by mid-July.

What to watch:

  • Official monthly updates on the progress of the rains.

INTERNAL SECURITY

Anti-India protests in Kashmir claimed eight lives in June. If the government fails to resolve the growing protests, they could weaken efforts to reach out to moderate separatists and the region could slide into another phase of armed uprising. If New Delhi links the protests to Islamabad this could hurt tentative efforts by both sides to repair relations. Violence by Maoist rebels is on the rise as they respond to a government security offensive involving thousands of police. At least 26 policemen were killed in an ambush on June 29. The threat from foreign militants also remains high. Some militant groups see India as a key battleground, and Pakistan remains a haven for militants seeking to launch attacks in India.

What to watch:

  • A meeting of the foreign ministers of India and Pakistan in Islamabad on July 15 aimed at further reducing tensions.
  • How fast the government can cool tempers in Kashmir.
  • The government has stepped up its offensive against the Maoist rebels but the risk of more attacks, especially on targets with economic importance, has risen.
  • The danger of militant attacks. Markets have proven highly resilient to terrorism — the impact was very limited even when gunmen rampaged through Mumbai in 2008. But an attack which sharply raised the prospects of conflict with Pakistan would have a strongly negative impact on asset prices, particularly in the current risk-averse climate in global markets.
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