>INDIA WATCH (HSBC)

Stepping up structural reform?

• Pace of reform may disappoint an expectant audience
• Left of Congress party and debate over the appropriate economic model imply a cautious approach will continue
• Significant labour market reform remains unlikely

Now that the dust has settled after India’s surprising general election results, we can consider the prospects for reform. With the Congress-led government in a far more comfortable position in Parliament, many expect the pace of change to pick up. Such optimism no doubt helps to explain the post-election leap in Indian markets.

But before we all get too carried away, a couple of observations are worth making. First, while the Prime Minister and many of his cabinet are reform-minded, Sonia Gandhi and her son Rahul are also crucial to decision-making, and they stand to the left of the Congress party. We suspect their priority is not so much business and financial-sector change as promoting the welfare of the hundreds of millions of people in rural areas and the urban poor. Many attribute the party’s electoral success to measures such as the farm loan-waiver scheme and the rural workers employment-guarantee programme.

Second, in view of the acute problems in the West, a global debate is taking place over the merits of a highly liberalised financial system. During the election campaign, many in the UPA coalition suggested one reason India had outperformed during the worldwide recession was precisely because it hadn’t liberalised as much as some, but had maintained a large state-owned banking sector and limits on foreign investment in certain areas.

This is not to say the government will ignore reform during its next five-year term. But it is likely to remain slow and cautious, in our view. In particular, we would be surprised to see labour-market changes intended to make it easier to hire and fire workers. Greater privatisation and cuts to government bureaucracy would provide a much-needed boost to government revenue, but they may be considered a step too far for now. That raises the question of how the huge budgetary shortfall will be addressed. So far, the new finance minister, Mr. Mukherjee, has argued things will look better once the recovery gets under way. He is correct, of course, but recent events have taught us the country doesn’t have just a cyclical budget problem – it has a structural one as well.

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