By Rajesh Kumar Singh and Manoj Kumar
NEW DELHI (Reuters) - The Congress party's drubbing in state elections proved beyond doubt that its populist politics failed to resonate with voters, and yet investors and consumers alike are bracing for more of the same from India's besieged ruling party.
Hemmed in by maverick allies and the fallout from a slew of corruption scandals, the Congress party-led federal government has failed to carry out any meaningful structural reforms since it was re-elected in 2009.
Investors had hoped a strong performance in the state elections would ease political constraints on Prime Minister Manmohan Singh, giving him room to revisit politically contentious reforms.
"As things stand now, they won't be able to bring any reforms. Their own allies will oppose everything," said D. H. Pai Panandiker, who heads Mumbai-based think-tank RPG Foundation.
Some reforms, such as to land acquisition and foreign investment rules, and the sensitive issue of subsidies on fuel, are crucial to lifting investment and spending in an economy headed for its slowest growth in three years.
Tuesday's poll results, showing Congress fared badly in four of five states, altered the odds of any such push for reforms in the federal budget.
Rather than becoming the catalyst for a renewed reform push, the state elections would provoke more populism, was the consensus view of analysts.
That is likely to mean more spending on social programs, such as a pledge to provide universal food security that could bleed public finances but help Congress' federal re-election bid in 2014. The budget for the fiscal year that begins April 1 will be unveiled on March 16.
SLOWING GROWTH, POLITICAL LOGJAM
India's economic growth is forecast to dip below 7 percent this fiscal year, the lowest since the 2008 financial crisis, as a political logjam and the central bank's aggressive policies to contain inflation hit capital investment.
After the state elections, Singh's government was widely expected to implement a decision to open India's $450 billion supermarket sector to foreign firms such as Wal-Mart Stores Inc. It had been forced to backtrack on that policy late last year in the face of a strong political backlash.
New Delhi is also considering raising domestic fuel prices in order to ease its subsidy burden, a politically unpopular move for which it may not have the stomach.
"People are worried now that the government will make a compromise in the budget," said Taina Erajuuri, a Helsinki-based portfolio manager at FIM India. "The worry is that the government will increase the social expenditure at the cost of reforms. Foreigners do not want to see that."
Stocks fell more than 1 percent on Tuesday to their lowest close in more than five weeks, and a further half percent on Wednesday, although the declines were broadly in line with other Asian markets and the main Mumbai index remains up more than 10 percent for the year-to-date. The rupee posted its biggest single session fall in six weeks on Tuesday.
Federal bonds failed to rally despite the Reserve Bank of India's plan to buy a higher-than-average amount of debt this week as a negative outcome for the Congress party doused hopes of a credible fiscal consolidation roadmap.
RESISTANCE TO REFORMS
It's one thing for the ruling United Progressive Alliance (UPA), which is led by the Congress, to admit its policies centered around handouts and higher rural wages have failed. It's quite another to try and push for higher taxes and transparency in the face of an energized opposition and squabbling coalition.
Still, several analysts reckoned the Congress leadership will see the writing on the wall, leaving it little choice.
"It's time for Congress to perform or perish," said Arun Kejriwal, strategist at Mumbai-based advisory firm KRIS, arguing for the government to put in place policies that may encourage business and create more jobs for voters.
"If this budget doesn't give any direction to the economy, Congress is likely to find itself in a mess in 2014, because next year's budget would be too late to do anything substantial for the economy," he said.
The easy option would be for the finance minister to sneak in reforms that don't need parliamentary approval, such as raising fuel prices or permitting more foreign holding of Indian bonds.
"This setback might be the final push to convince the UPA to bring in critical supply-side reforms to improve economic prospects," analysts at Standard Chartered Bank said in a note.
Before the global financial crisis of 2008, India's growth capacity was estimated at around 8.5 percent. But a lack of economic reforms since then has shaved that growth potential to a 7-7.5 percent annual pace.
Having failed to cut its subsidy bill, New Delhi is widely expected to miss by a long chalk its deficit target of 4.6 percent of GDP for the fiscal year that ends in March.
With global crude prices touching a new high on mounting geopolitical tensions, subsidy payout for the next year is only expected to rise unless pump prices are raised.
But for a party that has tasted electoral success on the back of welfare schemes for the poor and subsistence farmers, pleasing investors may not be easy as its seeks re-election in 2014.
"There is a risk that the government might opt for a more populist budget and rethink any possible decisions to trim subsidies -- which might hurt their support base at the grassroot level," said Radhika Rao, economist, at Forecast PTE in Singapore.
"The coalition administration will be hard at work in the run-up to the parliamentary elections in next two years, with odds skewed for another overshoot in 2012/13 fiscal deficit, at least over 5.0 percent of GDP."
($1=50.36 Indian rupees)
(Additional reporting by Sanjeev Choudhury and Anurag Kotoky; Editing by Vidya Ranganathan, Tony Munroe and Alex Richardson)