New Delhi: Prospects for reforms in India may have brightened after the Congress party’s election victory, but the government is likely to adopt a gradual approach due to the global recession and its need to stay popular with voters.
Expectations of rapid economic change to attract foreign investment have risen after the Congress party alliance was just short of a parliamentary majority, meaning it would not depend on support from regional allies or the communists.
While the communists blocked many reforms in the last Congress government, the party now has a free hand. Indian shares gained 17% on Monday, triggering a early halt to trading, on expectations of reforms and market-friendly policies.
Traders may be too optimistic. The left-of-centre Congress could tiptoe on reforms ranging from relaxation of labour laws to financial sector deregulation and privatization.
“A reform overdrive is unlikely not because political constraints have lessened, but because the financial turmoil has raised concerns globally — unfounded or otherwise — about financial liberalisation,” said Jahangir Aziz, India chief economist at JP Morgan.
Growth in Asia’s third-largest economy is expected to slow to a seven-year low of about 6% this fiscal year from around 7% in 2008-09, and from rates of 9% or more in the previous years. Millions of jobs have already been lost.
In a first glimpse of a gradual approach, trade minister Kamal Nath said India should focus on reviving the economy and the job market through domestic demand and investment.
“We will have to be cautious about financial sector reforms. Some of the icons of the financial world who were advocating financial reforms have closed shop,” Nath told Reuters on Sunday.
The Reserve Bank of India said last month it would delay a planned review of whether to give foreign banks a greater role in India until the global financial system had recovered.
JP Morgan’s Aziz said that unlike a 1991-92 downturn, which was seen as a crisis and tackled with fundamental market reforms, the current slowdown is seen as a collateral damage from a global shock and the need for reforms was less urgent.
Financial Sector Reforms
While the global crunch may have made market reforms unfashionable, it is the Congress party itself that may prove a bigger obstacle to deep change.
Congress won the election not just because of four years of rapid growth, but because of its mantra of inclusive growth, including expensive measures such as rural employment schemes and a farm loan waiver.
“We will take the reforms agenda forward, but not at the cost of development and not at the cost of state firms,” Congress leader Prithviraj Chauhan told a television channel.
These schemes won millions of votes but helped to widen the fiscal deficit to an estimated 10% of GDP, the highest since the early 1990s.
Congress will always bear in mind that a BJP government lost the 2004 election despite an economic boom. Congress leaders believe the deficit is not a problem compared with India’s massive social needs.
Reforms such as making it easier to dismiss workers, privatization which could lead to job losses, and financial sector changes which could hurt state-run insurance firms and banks could all damage Congress’s popularity.
Anyone expecting the government to raise the foreign investment limit in the insurance sector to 49% from 26% and to open up the pension system to foreign participation — policies that have been pending for parliamentary approval — may have to wait a while.
“It will be a careful and gradual approach, and everything will be examined on its merit and things which look risky will not be pursued,” said Saumitra Chaudhuri, economic adviser at domestic ratings agency ICRA.
Many government leaders, including Prime Minister Manmohan Singh, are reform-minded and will try to rein in the deficit while stimulating the economy.
No one expects a reckless, populist drive. Any widening of the large fiscal deficit could undermine the central bank’s efforts to keep interest rates low to support growth.
“A fiscal blow-out — as feared by some investors owing to coalition politics — is unlikely,” said Rajeev Malik, economist at Macquarie Securities.