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Barely three weeks ago, there was a new buoyancy in New Delhi. The Congress-led coalition government had won a vote of confidence in Parliament in favor of the U.S.-India civilian nuclear deal [BusinessWeek.com, 07/22/08]. To protest the controversial deal, the Communists, uneasy coalition partners with Congress since 2004, quit the government. Free of the Communists and fresh from its nuclear-deal triumph, the government, it appeared, was finally set to pick up the baton on economic reforms.



But many observers worry the government is about to squander this golden opportunity. Right after the vote, Prime Minister Manmohan Singh said he'd look at financial reforms and divestment, but since then his government has made just a single significant move: allowing select private players to manage public pension funds for the first time.



And events may be overtaking New Delhi's intentions. In July, Fitch downgraded India from stable to negative, and Standard & Poor's (MHP) issued a warning that the country's sovereign credit-rating outlook may turn negative. On Aug. 4, Moody's (MCO) also cautioned investors about a possible downgrade of India's credit rating. The culprit is inflation, now over 12%. India's public finances are feeling the pressure from high oil and fertilizer subsidies, hefty payouts for government employees -- which will equal 2.4% of the country's $1 trillion gross domestic product -- and a $15 billion farm debt forgiveness program whose efficacy has yet to be determined. "Higher oil prices and the lack of adequate fiscal policy reactions amidst high pent-up price pressures are putting the burden of macro-economic adjustment on the monetary authorities," wrote Moody's senior analyst Aninda Mitra in the report.



Slowing Growth

If rating agencies downgrade India's debt to below investment grade, debt-servicing costs to the government and private companies will skyrocket. Indian companies have been on an expansion spree, and are planning to put billions into capital expansion in the next few years. They have also borrowed billions more from lenders to finance foreign acquisitions, such as Tata Motors' purchase of Jaguar and Land Rover from Ford (F).



The outlook for growth at home [BusinessWeek.com, 07/01/08] is also less cheerful. Economists predict a slowdown in India's hot-paced economic expansion, to 7.5% in 2009, from the heady 9% of the past three years. Earnings growth is already slowing: For the quarter ended June 2008, corporate earnings grew 9% on average, compared with 29% during the same period last year, according to a report by Morgan Stanley (MS). The country's overall deficit, including India's states and its off-balance-sheet accounts, has ballooned to 10.5% of GDP this year, up from 6.5% last year. Economists expect the budget deficit, $32 billion last year, to hit $45 billion this year because of oil subsidies and the $15 billion in farm debt forgiveness.



No one is predicting an upturn soon, particularly given the nature of India's coalition politics, where stops and starts have become the norm and plans are rarely implemented in full. "For a sustained 9% and above growth rate, India needs to have more supply-side reforms," says Ananthasubramanian Prasanna, chief economist at ICICI Securities



What can Singh do, with national elections around the corner and just eight months left in office? There's plenty of work to be done, including pushing forward with an infrastructure and urban renewal program, for one. "And there are whole new areas awaiting change: the legal system, urban governance, administrative reform, and others," says Sanjeev Sanyal, investment adviser and chief economist for Deutsche Bank (DB) in Singapore. But economists aren't holding their breath. They expect the government to pursue only minimal changes that won't require legislation, rather than tackle big-ticket items. "The precedent for reform in this scenario is bleak," says Subir Gokarn, chief economist for Asia-Pacific at S&P.



One thing the government has done is announce some finance reform. For instance, it will allow private players like HSBC (HBC), ICICI Prudential, and Reliance Capital to manage its mammoth $60 billion pension fund, which takes in an additional $7.5 billion in fresh money every year. Until now, only the government-run State Bank of India had permission to manage that money. New Delhi also plans to permit foreigners to own 49% of insurance companies, up from 26%. And it plans to look into gradually lifting a 60% subsidy on fuel, intended to alleviate losses at state-owned oil marketing companies, until India's fuel prices are on par with production costs.



Considering Privatization

To reduce the strain on government finances, New Delhi has brought up the issue of privatization of state assets -- something it promised it would never do when it came to power in 2004. That would brighten India's prospects a lot and draw domestic and foreign investment into often inefficient public sector companies. Until recently, the state has dominated business. All the country's major oil companies are state-owned; so are the major mineral mining and food distribution companies, railways, and the postal system. Until a decade ago, most steel and aluminum operations were also state-run, as were banks and telecommunications. Now steel, banking, telecom, and mining have begun to let in fresh private air, with excellent results.



Despite signals it might consider privatizing, governments past and present [including those led by Congress as well as the opposition Bharatiya Janata Party] have maintained tight control over state-owned companies, using them for political patronage, investing very little, and enfeebling them over the years as a result. According to New Delhi researcher Prime Database, in the past four years the state sector raised just $23 billion in overseas and domestic equity and debt offerings. Their private-sector counterparts garnered a massive $76 billion.



It's a pity, says ICICI Securities' economist Prasanna, because while many of India's state-owned companies -- like power provider NTPC, heavy-duty turbine and boiler maker Bharat Heavy Electricals, and Oil & Natural Gas -- are stellar performers and globally competitive, others, like oil majors Indian Oil, Hindustan Petroleum, and Bharat Petroleum, which have been surviving on subsidies, went into a tailspin when crude oil prices rose. Even Air India has been chalking up losses. In 2005, New Delhi approved a $7.5 billion budget for Air India to buy 68 new aircraft from Boeing (BA). The airline is still losing money.



Although a three-year bull market has ended and shares in Mumbai are down 25% so far this year, the government is pushing ahead with plans to raise funds. For instance, it has lined up a $10 billion public sale of telecom behemoth Bharat Sanchar Nigam, even though unions oppose the divestment. If the deal goes through, it will be India's largest. On Aug. 6 government-owned hydropower generator NHPC announced that it would raise $600 billion from a public issue. By October, after years of delay, New Delhi will auction off spectrum licenses for 3G, the high-speed third-generation technology for mobile communications, which will help it raise around $9.5 billion. "We are trying our best," says a government source.



Such efforts represent an achievement for a government that has been chronically lax on reform, say analysts. Nobody expects Singh to open up privatization's floodgates or to rush through any more change. "Where is the time for all that?" asks Morgan Stanley economist Chetan Ahya. "Singh will have to spend a lot of time on the nuclear deal itself." The next few months could be the busiest of Singh's four-year tenure.