FACTBOX-Key political risks to watch in India

By Krittivas Mukherjee

NEW DELHI, April 1 (BestGrowthStock) – Investors who had bet on
swift economic reforms in India following the strong mandate
won by the Congress-led government in elections last year have
been disappointed — the government has been wary of pushing
through controversial measures, and is now struggling with
rising inflation and a weaker position in parliament.

Following is a summary of key risks to watch:

* INFLATION, AND MONETARY AND FISCAL POLICY

Inflation, and in particular spiralling food prices,
presents a key challenge for the government, which has
struggled to find a solution. In a surprise offcycle move on
March 19, the Reserve Bank of India raised key rates by 25
basis points for the first time since it began cutting in 2008.
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Rising demand-side pressure, which has begun to push up
headline inflation to near 10 percent, means a further rate
increase is likely at the next central bank policy review on
April 20. Analysts expect a 25 basis points hike, but the
central bank’s recent comments on inflationary pressures were
hawkish and if the hike is larger, it may hit bonds and stocks.
The RBI is less likely to increase banks’ cash reserve ratio.

The government plans to borrow a record 4.57 trillion
rupees in 2010/11, 1.3 percent more than the previous year, to
fund a fiscal deficit projected at 5.5 percent of GDP. To help
fund this it plans bond sales of 2.87 trillion rupees ($64
billion), 63 percent of its record full-year issuance target,
in the first half of the new fiscal year.

What to watch:

— Price stability is crucial for economic growth to
benefit the broader population. If inflation does not moderate
as expected, it could lead to aggressive monetary action which
could impact growth and spark political protests.

— Comments by key government and central bank officials on
the timing and scale of rate rises. Persistent policy
uncertainty and inflation concerns would weigh on debt prices.
(IN10YT=RR: )

— If food prices continue to stoke social discontent, the
government may feel less inclined to push ahead with economic
reforms, with a broadly negative impact on Indian markets.

— With most developed countries still operating at
near-zero percent rate levels, high interest rate in emerging
economies provide arbitrage opportunities.

— Bank credit, which is at 15.8 percent, is still far from
picking up, so a full-throttle charge to a higher rate regime
could pose greater problems for credit growth.

— The volume of government borrowing may exert pressure on
bond yields, and the central bank has said managing the
government’s debt programme this year will be a challenge. The
bank may not buy back as many bonds as it did last year, as it
does not want to increase liquidity when inflationary pressures
are mounting. The RBI is also constrained by the fact that it
has nearly exhausted its stock of Market Stabilisation Scheme
bonds which are used to absorb liquidity from the markets.

* ECONOMIC REFORM

While the government had appeared to be in a strong
position to press forward with an ambitious economic reform
agenda after last year’s wider-than-expected election victory,
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, disinvest in some 60 state-run firms and
formed an experts panel to ease foreign investment in the
financial sector — steps markets would regard positively.
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But it has repeatedly backtracked after street protests —
such as over labour reforms and freeing up farm prices —
raising doubts about firm governance needed to implement
reform.

The government’s ability to push through key legislation,
including financial reforms measures, will be tested when
parliament reconvenes from April 15. Its parliamentary majority
has narrowed after two of its partners withdrew support because
of differences over bills reserving parliamentary seats for
women and underwriting liability from nuclear accidents.

What to watch:

— Announcements on moves to privatise some state firms,
relax restrictions on foreign direct investment, ease limits on
foreign banks, and reform labour laws. The government’s plans
to open up insurance and pensions to foreign firms are now in
doubt.

— Important reforms such as stake sales in state firms
could be hampered if adverse political or global economic
developments spark volatility in domestic markets. The
government plans to raise 400 billion rupees from stake sales
to cut its deficit.

— The failure to move on the nuclear bill has prevented
U.S. nuclear firms from accessing India’s estimated $150
billion nuclear power market and frustrated Washington.

* EXTERNAL SECURITY

With India and Pakistan holding their first official talks
since the 2008 Mumbai attacks, hopes have risen of a calibrated
reduction in tensions, despite a bombing in the western Indian
city of Pune and an attack on Indians in Afghanistan. India has
so far refrained from pointing a finger of blame towards
Pakistan. But relations remain fraught and another major attack
in India could severely test India’s patience and put the
Indian government under tremendous pressure to stop its
tentative dialogue with Pakistan.

The two countries are also jockeying for influence in
Afghanistan, preparing for any political vacuum from a U.S.
exit. This could further worsen their relations.

Military conflict remains only a very slim possibility. But
a limited confrontation cannot be ruled out if Pakistan-based
militants once again launch a major attack on Indian soil,
making India-Pakistan conflict an unpredictable risk. And
Pakistan’s weak government, under threat on several fronts, may
have its own reasons to focus popular anger on India.
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In comparison, ties between India and China, which remained
uneasy throughout 2009 amid reports of border incursions and an
occasional war of words, are witnessing a period of calm.

What to watch:

— Signs of further thaw in India-Pakistan ties and
progress on more substantive talks. Any sign of rapprochement
would be greeted positively by investors, but would not have a
significant short-term market impact.

* INTERNAL SECURITY

The risk of violent attacks by domestic insurgent groups or
foreign militants remains high, underlined by the recent Pune
bombing that killed 16 people. Al Qaeda and affiliated groups
see India as a key battleground, and Pakistan is likely to
remain a haven for militants seeking to launch attacks in
India. Security forces are also battling a Maoist insurgency
spreading across large swathes of countryside, much of it rich
in minerals.

What to watch:

— The danger of new attacks. Investors have priced in the
threat level in India, as the muted market reaction to the
Mumbai attacks showed, but attacks causing a serious
deterioration in relations with Pakistan would be
market-negative. [ID:nGEE5B5050]

Investing Advice

(Additional reporting by Abhijit Neogy; Editing by Andrew
Marshall)

FACTBOX-Key political risks to watch in India