Is there reason for investors to be concerned about issues other than the cyclical slowdown? While everybody continues to make the customary obeisance to the so-called “long-term India story", there are signs that political factors could severely dent that potential.

First we appear to have a crisis of governance, graphically illustrated by the spectacle of senior cabinet ministers kowtowing to placate a yoga guru. The police action that followed seems to indicate the Congress party and the government are working at cross-purposes. The constant sniping between Digvijay Singh and home minister P. Chidambaram has also been sending the wrong signals. Add to that the power and importance given to so-called civil society groups such as the National Advisory Council (NAC) and their running battles with ministries and government agencies such as the Planning Commission and the perception is a complete lack of coherence.

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So far, it hasn’t made much of a difference. Economic growth has been strong and the government can claim credit for steering the economy through the financial crisis with one of the highest growth rates in the world. Even after its hawkish monetary policy, the Reserve Bank of India (RBI) believes that the lowest growth can go this fiscal is 7.4%. And while the government has been unable to check inflation, part of the reason is higher international commodity prices. More importantly, the opposition has shown a strange reluctance to make inflation an issue, perhaps realizing that high real gross domestic product (GDP) growth, which means growth after inflation, results in more income with people and therefore a greater ability to withstand higher prices.

It is also surprising the government has not been able to capitalize on its achievements on the social front. The Mahatma Gandhi National Rural Employment Guarantee Scheme has been a big success in raising wage rates. There have been notable successes in achieving literacy. The UN human development reports (HDRs) show India improved its ranking in the human development index (HDI) from 127 in 2004 to 119 in 2010. The HDRs also measure a country’s GDP per capita rank minus its human development index rank. This indicates how well a country is using its economic growth to better its human development status. India’s per capita GDP rank minus HDI rank was -6 in 2010, which shows it can do more social development given its strong economic growth. But this number was -10 in 2004, so there has been some progress, though certainly not enough. But with the Right to Education Act and now a food security law on the anvil, the government can point with some degree of confidence to its record on the social front.

There have been other important initiatives, perhaps the most important being the work on the goods and services tax, which is being held up simply because the opposition is playing politics. The unique identification initiative too holds out a lot of promise. The Right to Information Act has done wonders for transparency.

The problem, however, is that the government seems to have completely jettisoned economic reform. A simple matter such as raising the limit on foreign direct investment (FDI) in insurance to 49%—a move that won’t even give a majority stake to foreign companies—is still pending. Worse, even simple decisions, such as the Vedanta-Cairn India deal, are not taken, sending out wrong signals to foreign investors. Subsidy reform on diesel and cooking gas, a policy on urea, banking reforms, FDI in retail—there’s a long pending list.

The paralysis on reforms has already had an impact on FDI in FY11. And with the credit-deposit ratio at such a high level in banks, foreign investment is needed to generate resources for growth, even in the short term.

Perhaps the most contentious issue is that of land acquisition. The recent proposal by the NAC is likely to be unworkable, anti-industry and it will result in huge delays in project implementation. A report by a foreign brokerage points out that it’s therefore not surprising that Indian firms look out for investment opportunities overseas, rather than within the country.

Moreover, reforms are also the best way to reduce government corruption. They ensure competition, reduce the scope for discretion and increase transparency. For example, everybody knows how petty corruption in Mahanagar Telephone Nigam Ltd ended once private operators were allowed in. Remember the black market in cement during the licence raj? The less the government has to do with business, the lower the scope for grand larceny.

At the end of April 2009, before the United Progressive Alliance (UPA) was voted to power for the second time, the performance of the Indian stock market was well below that of its peers.

That changed dramatically after the election results showed the UPA would be able to form a government without the support of the Left, with the market triggering the circuit breaker on the upside on 18 May 2009. That early promise of reform has been completely belied.

The government must get its nerve back—the next general election is a long way off. In the meantime, it must be seen to do what it is a government’s job to do—govern. The choice before it is very clear. If the UPA is to achieve its cherished social objectives, high growth is a must. And the only way to achieve that growth is by boosting business confidence through economic reform and investment-friendly policies. Investors need to be reassured the government understands this simple truth.

Manas Chakravarty looks at trends and issues in the financial markets. Comment at