Senior Research Fellow, Asia Programme

India's short-term economic and political destiny is likely to become clearer in the next week or so. Last week, the government finally took the anticipated decision to launch the most significant swathe of economic reforms in recent years. First it announced an increase in the price of diesel – a necessary and delayed measure intended to help tackle the country's fiscal deficit. Then it announced that it would allow foreign investment in the retail sector and aviation, and seek to raise funds by privatising some state-owned companies. 

The moves had been expected earlier in the summer, but delayed in response to poor monsoon rains. And the political response was not unexpected. The most controversial reform was to allow 51% FDI in the multi-brand retail sector (foreign firms selling single brand goods were already allowed to operate in India). A key member of the ruling coalition, the Trinamul Congress, had already announced its opposition to the move, and in an attempt to appease it the government conceded that the implementation of the policy would be left to the states. In essence, if West Bengal did not want foreign-owned shops, that was its right.

Foreign investment in retail faces opposition on ideological and expedient grounds. Many left-wing parties fear that foreign-owned retail could threaten the livelihoods of millions of people employed in the current formal and informal retail sectors. Something like 40million people - 10% of the labour force - work in India's highly-fragmented retail sector. While the government hopes that the move to allow foreign investment will improve supply-chain management and benefit farmers, the left parties fear the impact on employment.

The main opposition party, the BJP, supported retail sector liberalisation when it was in government. Its opposition falls into the camp of expediency, and some within the party are thought to be unhappy with its current stance. If the government does fall, the ruling Congress Party is certain to emphasise the BJP's policy vacillation in the election campaign.   

The Trinamul Congress will decide whether or not to leave the government in the next few days. If it does withdraw, the government will need to find an alternative party to replace it or else face becoming a minority government and, in all likelihood, an early general election. The most likely replacement would be the Samajwadi Party. For now the Samajwadi Party is stressing its opposition to liberalization, but it may well be placated by some form of benefit package for the state of Uttar Pradesh.

The stakes on all sides are high. The government needs to demonstrate what it stands for to counter accusations of policy paralysis. But after a plethora of corruption scandals, and with a slowing economy, the opposition is relatively buoyant and looking for an excuse to bring down the government.

While many Indian economists believe that the country would benefit from economic liberalization, successive governments have failed to build a broad-based domestic constituency in support of reform.  Widespread opposition to reform has meant that there has been no significant vote in parliament for economic reform for years. Instead those reforms that have been implemented have involved changes to directives from the central bank and so forth, in turn reinforcing the notion that reform is somehow underhand. 

If the government manages to push through economic reforms that are seen to be widely beneficial, this will start to change. If it fails, the economic costs to India, and political costs to the Congress Party, are likely to be high.

Also read:

Indian Politics: Heating Up
Gareth Price, Expert Comment, September 2012

India's Economy: Reform Underway
Gareth Price, Expert Comment, June 2012