Investors Still Hope for India Fiscal Reform after Mixed Year

To its admirers, India’s ruling coalition has had a good year — sound fiscal policy to stave off a ruinous global credit crisis, fast growth and some tentative steps toward reforms.

Those are likely to be stressed by Prime Minister Manmohan Singh when he gives a news conference on Monday to mark the coalition’s first year in office.

But to its critics, his government has floundered on inflation, struggled ineffectively against a Maoist insurgency, and managed its political allies so badly its substantial parliamentary majority dwindled, hurting its ability to pass pro-market legislation needed to sustain robust growth.

A sense of bullish self-confidence marked the Congress party-led coalition’s handsome re-election victory last May, spurring hopes of firm governance and quick policy changes.
A slew of crises then undercut that electoral momentum, emboldened the opposition and weakened Congress’s hold on allies.

What may be more important though is that many investors remain optimistic India eventually will take steps to open the insurance, banking and retail sectors to overseas players, and India has too much potential for them to ignore in any case.

Incremental progress on structural reforms is the best they can hope for in a country of more than a billion people and 20 official languages still emerging from a socialist past. “We do not expect any radical implementation,” said Shubhada Rao, chief economist of Yes Bank in Mumbai.

“But we want the government to progressively start thinking about opening up the economy cautiously. The government’s reforms agenda is clearly outlined; what is needed is clarity on the road to implementation.”

Last May’s election gave Prime Minister Singh a freer hand, no longer relying on the communist parties that propped up his first term government.

Many investors wanted cuts in subsidies for fuel, fertilizer and food. They expected the government to move fast on removing supply bottlenecks blamed on state-controlled prices as well as poor roads and rail.

Instead, the coalition spent much of the year fighting political fires, from public anger over high prices to criticism over a growing Maoist insurgency and a high-profile ministerial resignation over a cricket funding scandal.

“The government should have been stronger, instead it moved from one bungle to another,” said Paranjoy Guha Thakurta, a leading newspaper columnist writing about India’s political economy.

In March, Singh lost some of his key allies as he tried to push through a bill reserving parliamentary seats for women. The thinning majority sent jitters through Congress before it cobbled the numbers to defeat a parliamentary vote on high prices.

While many say the government’s response to inflation, now running at an annual rate of nearly 10 percent, was the single biggest failure, its overall handing of the economy has been praised.

Car sales are up 40 percent year-on-year, industrial output grew by 10.4 percent in 2009-10 and consumer durables production surged by 30 percent in the last five months.

Recovering quicker than expected from the global crunch, India’s economy is forecast to grow at more than 7 percent this year and nearly 9 percent in 2011.

The government has also moved to sell stakes in some state-run firms, worked on a new tax code and is moving to repair public finances. It has sold spectrum to telecoms firms, which is expected to bring much needed funds for the budget.

To sustain grown, investors will be looking to the prime minister to introduce policies to improve India’s dilapidated roads, ports and airports and allow India’s large savings to be channeled into productive returns.

Analysts expect Singh to continue to support, but make slow progress on, bills that would liberalize insurance and banking and open up retail, which could resolve supply bottlenecks contributing to high inflation.

Another likely slow mover, given problems with Congress’s allies, will be a nuclear liability bill needed to allow entry of U.S. atomic energy firms into India.

“Gradualism punctuated by political compulsions will probably remain the key mantra,” Macquarie Research said in a new report that rated the governing United Progressive Alliance performance at an uninspiring six on a scale peaking at 10.

With 42 percent of Indians living on less than the poverty line of $1.25 a day, reforms have always been a political hot potato. Many farmers who receive subsidies for rice and wheat helped Congress win last year’s election.

“There is a lack of consensus within the Congress party and it is now increasingly clear the Left was only an excuse for postponing many important decisions needed to accelerate growth,” N.K. Singh, former finance secretary wrote in the Mint newspaper.

Despite lack of big-ticket reforms, foreign firms and investors are getting on with business undeterred. India’s long-term potential is too compelling to ignore.

“India is a delectable emerging economic story that suffers an unfortunate – but legitimate — discount because of its government’s poor management and implementation,” the Macquarie report said.

(Editing by Surojit Gupta and Jerry Norton)