India’s Economic Reforms in ‘Limbo’ as State Elections Near

By Sugita Katyal | August 30, 2010

Will India’s government succeed in passing key pro-market bills that have been in limbo for years? Not in the near future, say analysts.

With state elections around the corner, the Congress-led government may have lost a political window to push through crucial economic reforms because of fears of a backlash to sensitive decisions from voters already reeling from high prices.

But while reforms may take longer to enact, the government is committed to making them happen, and investors, for now, are putting up with the slow pace to reap the dividends from a vast consumer market in Asia’s third-biggest economy.

So far, the government’s boldest pro-market move has been to ease state controls on fuel prices, but it has made little headway in opening up pension and insurance, or liberalizing the retail and financial sectors because of opposition protests.

“The general consensus is that there is a lack of momentum on passing any of these bills except for nuclear liability … because Congress party is not very clear on direction,” Pratap Bhanu Mehta, president of the Centre for Policy Research, said.

A victory last year freed Prime Minister Manmohan Singh from his communist allies and raised hopes for reforms. But progress has been patchy as the government stumbled from crisis to crisis.

But even with this sluggish progress, India attracted nearly $35 billion in foreign direct investment in 2009, equivalent to 2.7 percent of its $1.29 trillion GDP.

China’s FDI totaled $95 billion in that year, or 1.9 percent of its $4.9 trillion GDP.

As the current session of parliament nears its end on Aug. 31, the government has only pushed through legislation on opening up the $150-billion nuclear power market crucial for the entry of firms such as U.S.-based General Electric and Westinghouse Electric, a subsidiary of Japan’s Toshiba Corp.

A bill to simplify archaic direct tax laws, a key piece of reform aimed at widening the tax net and increasing state revenues, may also be approved by parliament in this session.

But several other reform bills are unlikely to make it through with most of the session lost in the government defending itself against opposition attacks over issues like high prices.

High prices were blamed for the ruling party’s poor showing in local elections in the left bastion state of West Bengal. While inflation has since eased, food prices are still high, and party leaders will be wary of backing any measure that may further antagonize supporters.

Among the moves that may be delayed due to a lack of consensus are India’s most ambitious indirect tax reform, the proposed nationwide GST, and a proposed food security bill.

The GST proposal has been opposed by the Hindu-nationalist BJP and some states, who worry about the loss of their fiscal powers, and some analysts say this could delay the implementation of the reform beyond the targeted April 1, 2011.

Some reforms do not need legislation and can be pushed through an executive order, such as opening up the retail sector which is on hold because of opposition pressure.

The thorny issue of land acquisition for industrial purposes will also be on the backburner until the polls to avoid antagonizing farmers protesting over low compensation.

The Congress-led government has a slim majority in the lower house, but not in the upper house. The coalition is also composed of several small parties often suspicious of reforms, making the passage of bills subject to torturous negotiations.

If not passed, the bills can be taken up in the winter session, around November, but the pending state polls from the end of the year could narrow the political window.

State elections begin around November in eastern Bihar state followed by polls in the states of West Bengal and Kerala where the Congress party is trying to dislodge communist governments. There are six state elections over the next year.

The government, nonetheless, has made headway in some areas: it has pledged to sell stakes in some 60 state-run firms and formed an experts’ panel to ease foreign investment in the financial sector.

Despite setbacks and halting pace of reforms, accelerating growth, an expanding domestic consumer base and hopes for eventual liberalization will keep foreign funds flowing in.

Asia’s third-largest economy clocks the second-fastest rate of economic expansion among the major economies in the world and growth is set to accelerate.

But the government still needs to speed up the pace of reforms to deal with two of its biggest economic headaches: stubbornly high inflation and a massive fiscal deficit.

Headline inflation has been in double digits for several months though in July it eased to just below the 10 percent mark. The fiscal deficit was 6.9 percent of GDP in the last financial year and the government is aiming at 5.5 percent this year.

“The Indian National Congress-led governing coalition has a strong political mandate and appears to have enough dexterity to ensure the passage of key reforms,” Moody’s said in its latest credit analysis report on India.

“Parliamentary debate, state elections, and local issues may slow policy and reform implementation, but are unlikely to derail it,” the investment analysts added.

(Additional reporting by Krittivas Mukherjee; Editing by Alistair Scrutton and Miral Fahmy)

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