India’s reform prospects have not completely dimmed

Context

The long-delayed passage of key reform bills was once again impeded by political disruptions emanating from various corruption scandals and agitations during the recently concluded August-September monsoon session of parliament. This means that the government will now be forced to rely on executive policy decisions outside the parliamentary process to reassure investors in an environment of high inflation, slowing growth and global risk aversion.

While we still think that steps to rein in public spending and reduce subsidies are likely to be implemented before year end the window of opportunity for reform is closing. The political window to free urea prices, reduce fuel subsidies and facilitate FDI in a number of sectors will shut by the end of 2011 as the Uttar Pradesh state election campaign commences. Even as the political will to embrace reforms withers, investors should consider measures to rein in fuel and fertilizer subsidies as the minimum necessary for the government to retain its credibility.

Corruption agitation derails legislation

In our July 2011 note Ambitious reform agenda at risk, we pointed out that the Congress Party’s mixed response to recent corruption scandals could endanger its policy agenda by emboldening opposition parties to mount verbal attacks and disrupt parliamentary business. Such a reaction occurred when a government responded in a ham-handed fashion to Anna Hazare’s anti-corruption agitation.

As a result of opposition disruptions, the government managed to introduce only 13 of 34 planned new bills and to pass only 10 of 37 planned bills. None of the bills passed was specifically concerned with economic reform. Only two of the new bills introduced were relevant to the investment environment: one to regulate land acquisition and another to establish a nuclear safety regulatory authority.

Parliamentary standing committees presented another nine reports relating to pending bills, of which only one would be of particular interest to investors: a bill to establish an independent pensions regulator. The presentation of these committee reports is significant because until they have been submitted bills cannot proceed to the vote: reform opponents have stymied bills to liberalize banking and insurance by sitting on committee reports for months.

Table 1 shows how our predictions of policy movement fared in the recent parliamentary session:

Sources: PRS Legislative Research, TS analysis.

Reform decisions face increased opposition

With progress held up on the legislative side, the only hope for policy action between now and the November-December winter session lies with pending decisions to reduce subsidies and to remove FDI restrictions in multi-brand retail. Subsidy cuts are particularly important because the government now looks likely to overshoot its FY12 fiscal deficit target of 4.6 per cent of GDP by a considerable margin. Persistently high oil prices need to be transmitted to consumers, and the 15 September petrol price increase of 5 per cent needs to be matched by price increases in diesel, LPG and kerosene in order to be meaningful. A perception that it is unable to control its spending could accelerate portfolio outflows, something the government is keen to avoid under current market conditions.

However, the government’s political travails have emboldened reform opponents within the Congress-led coalition, as the following examples demonstrate:

• Urea decontrol. The Dravida Munnetra Kazagham (DMK) Party, which controls the Ministry of Chemicals and Fertilizers, continues to oppose the freeing of urea prices even though non-nitrogen fertilizer prices were decontrolled more than a year ago. A cabinet decision on this policy is required imminently for implementation by the stated deadline of 1 October.

• Fuel prices. The DMK and the West Bengal-based Trinamool Congress Party have strongly criticized the recent petrol price increases and demanded a rollback, even though fuel retailers are in theory free to set petrol prices. These Congress Party allies also forced the cancellation of a minister-level meeting on 16 September that was to discuss limiting the supply of subsidized LPG to four to six 14.2 kg cylinders per family and charging market prices for amounts greater than that. The proposal could reduce the LPG subsidy bill by up to Rs126 billion (US$2.7 billion), or more than 40 per cent of the projected FY12 total.

• FDI in retail. The proposal to permit 51 per cent FDI in multi-brand retail may already be an early casualty of the forthcoming Uttar Pradesh state election. The measure has been stuck after an inter-ministerial panel outlined its broad contours on 22 July. While we do not completely rule out a policy change it seems increasingly likely that the measure will be delayed until mid 2012. Liberalizing FDI in retail could theoretically anger Uttar Pradesh’s strong trader lobbies. In the interim, the government has decided to ease restrictions on wholesale cash-and-carry firms, in which FDI is currently permitted.

As Table 2 shows, the prospect for additional reforms has deteriorated somewhat. However, we still expect several to be pushed through.

Sources: News reports, TS analysis.

Conclusion

Although the outlook for these reforms has become cloudier, we believe that the government will push ahead with those aimed at reining in subsidies if only to retain a modicum of credibility after the anti-corruption agitations derailed earlier hopes that the economic reform programme would accelerate in 2011. Political divisions within the Congress Party have exacerbated its recent political setbacks, but we believe that the deteriorating economic environment will force its hand.

There are some positives to the current cloud of slowing growth and policy paralysis. FDI in April-July 2011 was up 92 per cent year on year to US$14.5 billion, compared with a 20 per cent drop in FY11 to US$30.4 billion compared to the previous financial year. After a long period of underinvestment in infrastructure, spending is picking up in roads, rail and urban infrastructure in spite of the very real governance and cost-of-financing concerns (although the government now expects to fall 10-12 per cent short of its 2007-12 infrastructure spending target of US$500 billion). Debt funds to increase the supply of long-term financing are in the process of being created, and corporate debt markets are deepening despite some regulatory barriers. The anti-corruption agitations are likely to spur new laws to increase transparency in government procurement and the allocation of natural resources by the state.

In the immediate future, however, we believe that the government will be beset by political difficulties and that its willingness to reform will be constrained by the Uttar Pradesh state elections that are likely to be held in February-March 2012. During this period we believe that the government will strive for action on subsidy reforms and perhaps FDI in retail – the minimum necessary to reassure investors that it is committed to broader reforms in the medium term.

Previous TS Research Publications

Other Research