Is India Ready to Push the Reset Button on Reforms?

Twenty-one years after initiating landmark economic reforms that unchained India’s growth and led to nearly 9 percent annual growth rates, India’s Prime Minister Manmohan Singh is once again fully in charge of economic policy.

India's Prime Minister Manmohan Singh
India's Prime Minister Manmohan Singh

Last month, Singh took charge of the finance ministry and called for a revival of "animal spirits" in the economy. The government recently began reviewing its policies on preventing large supermarket chains from entering the country.

Singh’s new dual role as both Prime Minister and Finance Minister, and his recent rhetoric aimed at boosting confidence in the business community, has reignited hopes for stalled reforms in Asia’s third-largest economy.

The market has reacted positively, helping to reverse the fall in the battered Indian rupee and providing a lift to the country’s stock market. The benchmark Sensex Index has risen 3.5 percent, while the rupee has appreciated 2.2 percent against the dollar, coming off record lows hit last month.

“It is refreshing to detect a greater degree of urgency to implement reforms from public officials,” Taimur Baig, Chief Economist at Deutsche Bank told CNBC.

“(But) the rhetoric needs to be followed with concrete actions expeditiously as investors are unlikely to give policy makers a prolonged period of benefit of doubt,” Baig added.

Singh, who gained credibility during his five years at the helm of India’s Finance Ministry starting in 1991, has been more recently known for his role as the leader of a government that has flip flopped on policy, failed to initiate reforms and been embroiled in a number of corruption scandals.

Reforms introduced by his government in recent years, including opening up the airline and insurance industries to overseas investments, as well as measures to improve the government’s fiscal position through lowering fuel subsidies have stalled due to opposition in parliament. In many cases that opposition has come from members of the ruling coalition.

Many Indian politicians fear that reforms will alienate the country’s largest voter base made up of farmers and lower-income rural residents.

However, Jagdish Bhagwati, former advisor to the Prime Minister, says recent electoral defeats for the ruling Congress Party, will motivate politicians, scared of losing in national elections in 2014, to push through stalled reforms.

“I’m pretty optimistic that politics will work out in such a way that we see the handwriting on the wall - all the guys who have been holding up further progress will give in, otherwise they don’t get elected. They have to make an honest living like the rest of us,” Bhagwati said.

Deutsche Bank’s Baig adds that the deterioration in growth and weakening of the government’s fiscal position will force policymakers, previously opposed to reforms, to support them.

“What was good for the economy - reviving growth and cutting the deficit - has now become potentially good for politics. The political and economic incentives are becoming aligned,” he said.

Rajeev Mallik, senior economist at CLSA, however, says while he expects a few reforms to be pushed through, investors shouldn’t expect a “born-again government” that is going to turn the economy around.

“The challenge in India is the implementation uncertainty because there are always political calculations involved,” he said.

Bhagwati agrees that reforms are unlikely to be as aggressive as those put in place two decades ago.

"In 1991 we had a balance of payments crisis, we ran out of forex reserves. (The) crisis had a big persona and had a huge multiplier effect. So when he (Singh) was reforming the system he could do so without excessive resistance," Bhagwati said.

By CNBC’s Ansuya Harjani