REFORM PROSPECTS IN NEW GOVERNMENT

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SUBJECT: REFORM PROSPECTS IN NEW GOVERNMENT

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Reftel Mumbai 198


1. (SBU) Summary: More than 400 million Indians cast their vote in
India's national parliamentary elections this past month and seem to
have decisively signaled that they want stability and continuity in
the national government, handing Congress an 18-year best
performance of more than 200 seats out of 543 seats in India's lower
house of Parliament, the Lok Sabha. With the Left parties reduced
to a fraction of their prior strength and the Congress-led UPA's
strength sufficient without Left support, expectations are soaring
high for Prime Minister Manmohan Singh to move on economic reforms.
Post expects passage of stalled legislation boosting foreign
investment in insurance, liberalizing voting rights in the banking
sector, and empowering the pension regulator, as well as partial
divestment of government stakes in public companies. However,
long-needed reforms in labor, education, energy, as well as FDI in
retail, may remain elusive or slow in coming. India Inc tripped the
upper circuit breakers of the Bombay Stock Exchange on May 16 but
its euphoria should be tempered and expectations lowered. Congress
still has allies to manage, as well as some areas of resistance from
within its own party and special interests. The way forward will be
much clearer in the next few weeks as the new government decides
ministerial assignments and issues a 100-day plan, which Post will
cover septel. End summary.

Unfettered Congress
--------------


2. (SBU) India Inc. and economists alike have noted their hopes in
recent days that the Congress' big win and comfortable margin in
Coalition numbers, without the Left's impediment, will lead to rapid
and further progress in reforms. The markets reflected this when
they opened on May 16 (reftel),responding with record one-day gains
to Congress' best win in 18 years, Manmohan Singh becoming the first
prime minister since Jawaharlal Nehru to be re-elected after serving
a five-year term, and the Left allies reduced to a shadow that is
not needed in the formation of a ruling coalition. All of these
developments have raised very high expectations that Prime Minister
Singh can now move unimpeded in implementing a full roster of
needed, but long stalled, second generation reforms.


3. (SBU) Commentators have been quick to identify both unfinished
legislative business as well as new reforms that the new government
is expected to take up. Post expects quick progress on stalled
legislation boosting foreign investment in insurance, liberalizing
voting rights in the banking sector, and empowering the pension
regulator, as well as partial divestment of government stakes in
public companies. But overdue reforms in labor as well as more FDI
into retail may take a back seat, as resistance and entrenched
interests exist outside of the Left parties on these issues. Kamal
Nath, former Commerce Minister, already claimed on May 16 that FDI
in retail would not be liberalized in the short term.

Low Hanging Fruit - Stalled Legislation
--------------


4. (SBU) With the Left no longer able to stymie passage of key
reform legislation, it is expected that already-introduced bills to
raise FDI in insurance, provide proportionate voting rights to bank
equity holders, and authorize the new pension regulator, the PFRDA,
will receive quick passage this summer in the new Parliament. The
insurance amendment bill, which proposes raising FDI in insurance
from the current 26% cap to 49%, was blocked by the Left parties and
some domestic firms. With the Left gone and all players now hurting
for investment, it should face no resistance. The pension bill,
named for the creation of the Pension Fund Regulatory and
Development Authority (PFRDA),has been mostly enacted already by
administrative fiat, and should easily pass. While the Parliament
must sit by June 2, it is likely to adjourn until the new Budget is
ready for introduction. Media are currently citing official
projections of 45 days to finalize and present the new budget, so
Post expects the Budget Session to kick off in earnest in early July
and last until early August. The government is also expected to
move quickly on permitting partial divestment in publicly-owned
companies, which not only would inject more discipline and

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efficiency into such companies, but help raise needed government
revenues.

Other Reforms Being Floated
--------------


5. (SBU) Media is also reporting that Ministries have been tasked
with forwarding new policies to the Cabinet, for formulation of a
100-day plan for the new government. Some proposals that have been
floated before, but not picked up, are supposed to be seeing new
life. These include a proposal to allow foreign airline carriers to
invest in Indian civil aviation companies. Foreign carriers are
currently banned, but the struggling aviation industry, hit by the
economic downturn, could use the capital infusion. A 3G auction to
license rights to use and sell "third generation" - 3G - mobile
phone and IT technology could also finally see the light of day, as
well as a long postponed spectrum policy. Licenses to coal mining
which are heavily tilted towards state-owned companies could be
expanded to more private players as well. The restriction on coal
mining not only prevents foreign investment in the industry but also
creates upstream input hurdles to prospective energy companies who
need to ensure sufficient and affordable coal inputs. The
government is reportedly also considering revising the highway
tender and bid process, as more than four-fifths of projects that
were offered in the last few years received no takers. All of these
would help improve infrastructure, which the government still
prioritizes but lacks sufficient funding to do without more private
participation.


6. (SBU) Hopes for reform of subsidies are also riding high. Press
reported that the Petroleum Ministry is supposedly drafting a policy
to decontrol fuel pricing, which cost the government, through its
oil marketing companies, roughly $25 billion last year when global
oil prices spiked. There is an argument to be made that most of the
fuel subsidies benefit the urban middle class. If many in Congress
feel that their win is due to their focus on the rural sector, the
high cost of this subsidy could be seen as usurping funds that could
be spent on extending the rural employment guarantee program and
needed rural infrastructure. Likewise, energy subsidies on kerosene
and cooking gas could be restructured to better target lower income
users, perhaps through the use of smart cards. Such technology
might also be introduced to streamline food subsidies, which cost
the government about $12 billion last year (roughly three times the
cost of the rural employment guarantee program),yet barely gets to
poverty-line recipients.

Probably Not So Fast
--------------


7. (SBU) After the election results were announced on May 16, many
press reports quickly pointed to improved chances for increased FDI
in retail, which was vociferously resisted by the Left parties.
Currently, only 51% FDI in single-brand retail and 100% FDI in
wholesale is allowed, while no FDI is allowed in multi-brand retail.
However, prospects for further opening the retail sector remain
questionable, as more than just the Left parties are concerned that
foreign organized retail will adversely impact the estimated 30-40
million mom-and-pop stores, known as kiranas. Reformers can point
to a report undertaken by prestigious think tank ICRIER that
indicated that kiranas would not necessarily be hurt by the growth
of organized retail and could co-exist with it. However, the
numerous and vocal critics of organized retail could still
successfully pressure the government to move very slowly on this
investment liberalization.


8. (SBU) Talk of reducing government holding in banks to below 50
percent, in order to facilitate consolidation in state-owned banks,
which control roughly 70% of total banking assets, may also be
premature. The central bank, the RBI, already signaled its
hesitation to embark on significant banking liberalization in its
April Monetary Policy Statement, putting on indefinite hold its
scheduled 2009 consideration of a "banking roadmap". Contacts and
commentators perceive that one of the fallouts of the global
financial crisis is a new wariness of foreign banks and the putative
benefits they bring to a domestic market. Finally, labor reform,

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still a critical project to nurture more employment creation,
especially in the historically anemic but recently nascent
manufacturing sector, remains dubious, given the number of
entrenched interests who are likely to resist such a major change.

Comment
--------------


9. (SBU) Opportunities for reform are significant, but with the
Left gone, anti-reformists in Congress and the UPA have had their
fig leaf taken away. There will still be some resistance to new
reforms, although existing proposed reforms - legislation to
increase FDI caps in insurance, give proportionate voting right to
bank shareholders and enactment of PFRDA - should move forward, as
will divestment, which the government needs for revenues. Allies'
handling of ministries has been a mixed bag and thus the ability to
implement these reforms will be affected by the assignment of
portfolios. On the upside, Congress' position of strength in
securing support above the minimum 272 seats means that it has more
leverage over these ministers' performance; something it lacked with
its razor thin majority in the last Lok Sabha.


10. The current large fiscal deficit (roughly 11 percent of GDP)
constrains the government from expanding its social programs without
rationalizing expenditures and finding new revenue sources. Prime
Minister Manmohan Singh, himself riding an impressive mandate as
only the second prime minister besides Jawaharlal Nehru to be
re-elected after a full five year term, has already tied reforms to
inclusive growth. It is likely that Singh will argue that the lack
of fiscal space requires moving forward with investment
liberalization and rationalization of expensive subsidies in order
to free up more government spending and stimulate private sector
investment in infrastructure. Fiscal constraints also may
necessitate more revenues through 3G auction and public sector
company divestment. The prospects for these reforms will become
clearer over the next few weeks, as the government announces
ministry appointments and possibly releases a 100-day plan that
could prioritize reform goals. Post will continue to monitor and
report.

BURLEIGH