Senior Research Fellow, Asia Programme

Recently, Indian politics has sprung to life. Criticisms of policy paralysis have been brushed aside by the announcement of economic reforms last week. A cabinet reshuffle seems imminent, as does the likelihood of more economic liberalization and a resumption of the 'divestment' (privatization) process.

The new approach of the Congress Party has sparked an angry response. The Trinamul Congress, a party whose heartland is in the state of West Bengal, has left the ruling coalition. The main opposition Bharatiya Janata Party (BJP) along with a host of left-wing parties have come out strongly against liberalization and the BJP has called for Prime Minister Manmohan Singh, to resign.

The BJP has claimed that the government is attempting to divert attention from the 'coalgate' scam. Under-pricing in the allocation of mining licences is claimed to have cost the government Rs 1.86trn, (US $35bn) equivalent to around 2% of India's GDP. Other elements of the BJP have claimed that the government is beholden to 'foreign powers' while a few former BJP ministers have expressed a degree of support for the reforms.

Congress is not yet a party of free marketeers, and the party's explanation for reforms seems more plausible than the BJP's allegations. This time last year one US dollar was worth around Rs 49. By June this year it was worth Rs 57, a decline in the rupee of more than 16%. The fall, which makes imports into India more expensive increasing inflationary pressures, stemmed from widening trade and current account deficits and a slowdown in portfolio flows into India. Moves to relax FDI rules were seen as one means to increase demand for the rupee and thus strengthen the currency.

But given the spate of corruption cases that have ensued over the past couple of years, allegations of malpractice are likely to stick. Hence the government is likely to move on those ministers most tarnished, freshen up the cabinet with some new faces, and rehabilitate some former ministers.

Put together, these changes are significant. Even more so, it seems that rather than simply initiating a one-off set of reforms, the government intends to push on, possibly increasing the caps for foreign investment in sectors such as insurance. However, eventually these reforms will require a parliamentary vote. This will raise two challenges. 

First, the BJP has disrupted parliament over the issue of coal licences. In its last session, parliament functioned for just six out of 19 days as the BJP called for the resignation of the prime minister. Only three bills were passed. Second, the government is now technically a minority government, relying on the support of the Samajwadi Party and the Bahujan Samaj Party (BSP), neither of which is particularly enamoured by the idea of economic reforms. But in the government's favour, few parties are currently prepared for an election campaign despite their rhetoric. 

Good Neighbours

While domestic politics has heated up, almost under the radar relations between India and Pakistan have continued their positive trajectory. Following an Indian delegation's visit to Pakistan last week, the two countries have agreed that from October the number of tradable items at the Attari-Wagah land border will increase from 137 to 6,000. India also offered to sell locomotives and gas to Pakistan. Some estimates suggest that bilateral trade could quickly rise tenfold, from its current level of US $2.5bn. 

Despite domestic political in-fighting in both India and Pakistan, there appears to be a growing consensus across (most of) the political spectrum in both countries that better economic relations between the two are both feasible and desirable. Given its location, India is the obvious country to help tackle Pakistan's economic woes. And in India there is a widespread recognition that a stable Pakistan is a preferable neighbour to an unstable one. 

Don't Give Up

Manmohan Singh has received a slew of criticism in the course of this parliament, largely because of the slew of corruption cases that have come to light. These in turn have resulted in a slowdown in political decision-making. The chances that he would be able to deliver on either of his preferred legacies had seemed slight. But a change in mind-set in Islamabad has given rise for the potential of a better relationship with Pakistan. And the economic slowdown – which threatened to undermine his reputation as India's economic reformer – appears to have sparked a willingness to take risks which could, potentially, reinvigorate the economy. 

If the government lasts deep into 2013 then there would be a chance for progress on both fronts to be consolidated. But with the political scene heating up, the BJP becoming more hostile and with a host of increasingly-important regional parties each acting upon localized considerations, that outcome is far from certain.

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Also read:

Economic Reform in India: Expect Political Backlash
Gareth Price, Expert Comment, September 2012

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