Key political risks to watch in India

Government faces accelerating inflation as it carefully tries to balance political and economical objectives.

India's government faces the prospect of accelerating inflation from higher food prices, even as it considers lifting diesel prices, and it will walk a thin line as it balances political and economic objectives.

Here is a summary of political risks to watch in India:

Corruption scandals paralyse government

Prime Minister Manmohan Singh's government has been bogged down by a series of corruption scandals linked to members of his party or government, the fallout from which has paralysed policy making and further delayed crucial economic reforms.

The opposition, which brought proceedings in parliament to a standstill late last year, has vowed to freeze lawmaking if the government does not set up a joint parliamentary committeeto investigate charges that India lost up to $39 billion due to graft in granting telecoms licences in 2008.

Police are also probing accusations that officials in state-run banks and financial institutions took bribes to grant loans to companies. They are also looking at possible corruption during the awarding of contracts for the Commonwealth Games in October.

Limiting the damage has sapped the government's energy, and the testy relationship with the opposition means it has had little opportunity to push for consensus on reforms such as a new tax code and opening up the retail sector to foreign companies.

Investors have largely shrugged off the scandals, seeing corruption as an emerging market risk which comes with the lucrative Indian market.

What to watch:

• Court hearings.

The Supreme Court is to decide if the prime minister shielded the telecoms minister from being investigated. If court rules he did not, if would be a blow for the opposition campaign, and may give the government the confidence to get its policy agenda back on track.

• Investigations.

Arrests or questioning of high profile people connected with the cases will indicate that the government is serious about tackling corruption.

Regulatory Risk

Investors are keenly watching the future of several telecoms licences and environmental permits that could be cancelled as the government takes a fresh look at them, a test of the reliability and stability of India's investment climate.

The environment ministry, which is taking an increasingly aggressive stance against big business, will decide whether to let South Korean steelmaker POSCO's go ahead with a $12 billion steel plant.

The telecoms ministry has asked several phone operators to defend their licences against charges by the state auditor that they did not meet the requirements for receiving them.

They include those held by the units of Telenor and Etisalat .

Revoking the licences or clearances would unnerve foreign investors and raise doubts about how reliable government policy and contracts are, ultimately detracting from India's attractiveness to investors.

What to watch out for:

• Decision on POSCO and licences.

The environment ministry has said it will decide by the end of January. The telecoms ministry has given the firms until mid-February to respond.

Inflation

Food price inflation is rising again, and fears it could feed into generalised inflation could defer a government decision to raise diesel prices and keep subsidies in check.

Rising food and fuel prices are deeply unpopular in a country where more than 40 percent of the 1.2 billion population lives on under $1.25 a day, and could cost the ruling Congress party in elections in three major states this year.

The Reserve Bank of India (RBI) has warned inflation is not cooling off as fast as it had expected and upside risks remain.  Economic growth is robust and with policymakers speaking of 9 percent expansion in the fiscal year to March 31, many analysts expect the RBI to reverse its earlier signal for a near-term pause in monetary tightening.

Headline inflation eased to 7.48 percent in November, its lowest level in a year, but this figure remains above the RBI's comfort zone of around 5 percent. Analysts see the policy rate rising at least 50 basis points by the end of the fiscal year.

What to watch out for:

• Decision on diesel prices.

The government deferred a meeting on prices, and has not yet decided on a new date. No movement would mean a higher subsidy bill and strain a target of 5.5 percent fiscal deficit in 2010/11.

• Inflation data.

An easing in food and headline inflation would take off pressure on the central bank to raise rates aggressively. December headline inflation data is due January 14.

• RBI policy review on January 25.

Hawkish comments on inflation in the review and from policymakers will determine the outlook for future rate hikes and would weigh on bonds.

Security

India is on high alert after intelligence reports that militants could strike cities around New Year. Police are still searching for four men they say are part of a Pakistan-based Lashkar-e-Taiba and have entered Mumbai to carry out an attack.

A bomb exploded in the northern city of Varanasi on December 7, killing a child and wounding at least 37 people.

Another attack like the 2008 militant strike in Mumbai that killed 166 people, and which India blamed on Pakistan-based militants, would raise the risk of an Indian retaliation.

The risk remains of Maoist rebels in India's heartland disrupting mining and rail networks, though the government has stepped up its offensive against them.

What to watch out for:

• Any attacks and the Indian response to them.


• Signs of progress in talks between India and Pakistan.

Protests for new state

Several Congress lawmakers have threatened to resign if a new state is not carved out of southern Andhra Pradesh. Were that to happen it would whittle down the coalition government's already-narrow majority.  Political passions in Andhra Pradesh have been fanned by a panel's report to the government on the possibility of creating Telengana state, splitting the local unit of the Congress into pro and anti-division camps.

The 33 Congress lawmakers from Andhra Pradesh are the single largest block of the party's 207 members in the 544-strong lower house of parliament. Of them, 17 are from the Telengana region.

A thinning of numbers would further weaken the government and jeopardise the passage of the 2011/12 budget.

What to watch out for:

• The contents of the report. They have not been made public yet and the recommendations are not binding on the government.