India’s prime minister leads policy changes, but it may be too little, too late

By David Sloan, Anjalika Bardalai, and Sasha Riser-Kositsky

India’s low-key Prime Minister Manmohan Singh has revealed unexpected backbone, but his renewed vigor may come too late to for India to avoid a ratings downgrade or save his unpopular government. After years of limited and haphazard progress on structural changes to the economy, the prime minister, in conjunction with the new Minister of Finance P. Chidambaram, has successfully leveraged the looming threat of a sovereign downgrade to reassume control — at least for now — over India’s economic policy-making. At the pair’s urging, India’s Cabinet Committee on Economic Affairs on September 14 approved 51 percent FDI in multi-brand retail, allowed foreign airlines to buy 49 percent stakes in Indian carriers, and raised the FDI cap in broadcasting services from 49 percent to 75 percent. Those long-awaited announcements came just one day after a cabinet committee also approved an unexpectedly large price increase for diesel.

The decision prompted a quick revolt by the second-largest party in the ruling United Progressive Alliance (UPA) coalition. Mamata Banerjee, the firebrand leader of the West Bengal-based Trinamool Congress (TMC), announced on September 18 that the TMC was withdrawing from the government after Singh ignored her demands to roll back both the diesel price hike and FDI liberalization.

But the TMC’s departure will not stop those measures from going ahead. The TMC’s move leaves the UPA even further from a simple majority in the Lok Sabha, but the government says it still has enough support from other regional parties to survive any possible confidence vote, at least in the near-term. The UPA’s ability to maintain the outside support of a number of regional parties — especially the Samajwadi Party (SP), which holds power in India’s largest state, Uttar Pradesh, and has 22 members of parliament in the Lok Sabha — is crucial to the coalition’s future. Although the SP has previously turned down ministerial positions and is likely to do so again in the now-inevitable cabinet shuffle, New Delhi will offer the state government significant financial incentives as an inducement. Still, the SP, along with the TMC a huge winner in recent state elections, expects that early national polls would significantly expand its parliamentary representation.

As such, while the government is likely to survive for now, the TMC’s exit underscores the fragility of the Congress-led UPA coalition and increases the chances for early national elections. If the SP and the main opposition Bharatiya Janata Party can resolve their internal leadership squabbles, they might support any TMC initiative to force early national elections. Otherwise, the UPA government is likely to limp along until the end of its five year term in mid-2014.

Despite the political firestorm, the government is unwilling to risk the reputational damage of backtracking again on FDI liberalization, as it did last December after initially approving FDI in multi-brand retail. But the prospects for further reforms have diminished as a result of the political turmoil. Any liberalization of FDI rules in pensions and insurance that would require legislative action is out of consideration, while implementation of the Direct Taxes Code and the Goods and Services Tax, which would require a constitutional amendment, is extremely unlikely. And while the government will move ahead with fiscal consolidation later this month, the window for new and deeper changes closes as national elections approach. Following the election, the prospects for reform are even bleaker as an even more divided, dysfunctional coalition government is likely to assume power.

David Sloan is head of Eurasia Group’s Asia practice, Anjalika Bardalai is an analyst in the Asia practice, and Sasha Riser-Kositsky is a researcher in the Asia practice.