Can India deliver reforms?

By Eurasia Group analyst Seema Desai

After the Congress party received a strong mandate in May 2009, investors hoped that India's unfinished reform agenda would resume. Without the left parties, which held back many market-oriented reforms during its previous term, they thought that the Congress party would be able to power ahead without opposition. The new government fed the euphoria, promising to implement a wide range of policies that would cheer investors -- including disinvestment in state owned enterprises, tax reforms, banking, and insurance reforms, and a move toward market pricing of fuel. The party also planned to institute policies that would improve the condition of farmers, develop better infrastructure (e.g., roads, transport systems, and electricity), free up energy markets, promote job growth, and push forward judicial reforms.

But the government's first 100 days, completed in late August, have been disappointing. Much of the progress so far has been on tax and fiscal policies that are essential to narrow the fiscal deficit which, at more than 10 percent of GDP, has reached alarming proportions. In other areas, such as banking and financial reforms, the government is moving slowly in the wake of the global financial crisis. Moreover, there has been no movement on reforms in the agriculture and energy sectors largely because of the complex vested interests involved.

Since the early 1990s, India has had successful reformist episodes in which the government has been able to prevail over vested interests, but these periods have typically occurred after an economic or financial crisis, or because the top leadership believed in reforms and fought off internal political opposition to them. Now, however, the leadership's mantra of inclusive growth clearly indicates a focus on redistribution -- high taxes for high welfare spending, with a focus on programs to uplift the disempowered in rural and urban areas.

While the overall prognosis for economic reforms during the rest of the government's term is not particularly promising, there will be important progress in certain areas. A new fiscal responsibility law, implementation of tax reforms, and disinvestment in state owned enterprises will happen in 2010 and 2011. Incremental policy changes in the finance and banking sectors are also likely. Kamal Nath, the new minister of roads and highways, is trying to start transport infrastructure building, though he has been inexplicably slow in announcing changes to the public-private partnership framework. None of these are areas will face major political opposition.

In contrast, freeing up agricultural markets and allowing the private sector to trade directly with farmers would mean challenging powerful rural vested interests, which the Congress party is unlikely to do. Facilitating an organized retail sector presents the same obstacles, as does allowing foreign direct investment in the retail industry. Fuel subsidies have long been a drain on India's public finances, but this government is unlikely to be brave enough to remove them and sustain free market prices for any serious length of time.

The best period for reform is between now and 2011, after which the government's focus will shift to the next general election, as well as the upcoming leadership change from Prime Minister Manmohan Singh to Rahul Gandhi, son of party leader Sonia Gandhi. Important state assembly elections (particularly in the battleground state of Uttar Pradesh in 2012) will also make the Congress party even more risk averse than it is now.