India: politics paralyses the economy

In India, "the bulls are now getting edgy", says JP Morgan. Global investors had flocked to the stockmarket in recent weeks, hoping for long overdue market-friendly reforms from the new finance minister P Chidambaran.

But the momentum has ebbed away in the past few days. Precious little has happened on the reform front and the opposition has stymied parliamentary proceedings amid the outcry over India's latest corruption scandal; a recent report by government auditors said coalfields had been sold to private firms too cheaply.

Adding to the sour mood was last week's latest GDP report. Growth reached just 5.5% year-on-year, the lowest figure in nearly a decade, in the second quarter. It's a stark reminder that "India's economic troubles are mostly self-inflicted", says Capital Economics.

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A key cause of the slowdown has been a deceleration in investment, as RBS points out, and this in turn is largely the politicians' fault. Last year, India was poised to open up its retail sector to foreign firms but vested interests thwarted the move at the last minute. The lack of a clear government policy on retrospective taxation has also created uncertainty. Another major problem has been government overspending, especially subsidies; the budget deficit is expected to reach 8.3% in 2012.

The loss of fiscal discipline has "crowded out private investment"and worsened inflation, says BNP Paribas. Meanwhile, interest-rate hikes have yet to squeeze out inflation of around 10% and the global slowdown isn't helping. India needs a "sustained reform effort" to bolster its growth trajectory, but this is likely to have to wait until after the next election in 2014, concludes BNP.

For long-term investors, however, this looks like a buying opportunity. There is still plenty of promise in a country that boasts a solid presence in global service industries such as pharmaceuticals and outsourcing; a fast-expanding working-age population (China's has peaked); and incomes per head are still at a third of Chinese levels. Our favourite India play, Aberdeen's New India Trust, looks cheap on a 13% discount to net asset value.