Key political, economic risks to watch in India

By Frank Jack Daniel

NEW DELHI (Reuters) - India's slowest economic growth in a decade could be even worse than anticipated, as preliminary data released in February showed the economy appears to have grown 5.0 percent in the fiscal year that ends this month - lower than both the RBI and finance minister's forecasts - underscoring the urgent need for reforms to boost growth.

RATINGS (Unchanged unless stated):

S&P: BBB-

MOODY'S: Baa3

FITCH: BBB-

Following is a summary of key political risks in India:

ELECTIONS AND ECONOMY

In his budget at the end of February, Finance Minister P. Chidambaram defied market expectations of spending cuts by promising a bigger outlay for the coming fiscal year, which falls just before an election.

The budget was an illustration of how he and Prime Minister Manmohan Singh are being pulled in different directions: by foreign investors who want fiscal discipline and reform, and by voters at home who would react badly to anything resembling austerity measures.

Total budget expenditure will hit 16.65 trillion rupees in the new fiscal year that begins on April 1, Chidambaram said, in comparison with spending in the 2012/13 fiscal year that is on track to hit 14.3 trillion rupees. Even while pledging higher spending, he said he had "no choice but to rationalise expenditure".

Ratings agencies Standard & Poor's and Fitch have threatened a downgrade if the fiscal deficit is not tamed.

Chidambaram, who has staked his reputation on hitting a fiscal deficit target of 5.3 percent of GDP this year, has tried with some success to please investors, introducing reforms such as allowing foreign supermarkets to enter India, but the budget was aimed squarely at Indian voters, many of whom are turning away from the ruling Congress party.

Long periods of gridlock in parliament, failure to pass promised reforms, and a series of corruption scandals have characterised Singh's second and final term in office, and the party is nervous about its prospects in polls due by May 2014.

In a high-profile speech in January, Rahul Gandhi appeared to embrace his role as a leading contender to be the country's next prime minister, though he gave few clues about his views on politics and the economy.

Gandhi, whose mother Sonia is president of the Congress party, will be the party's main hope for elections in the world's largest democracy.

What to watch:

- How share prices, bond prices and the rupee move as government spending rises.

- Official announcements of candidacy, or suggestions from leading politicians they may stand in 2014. Chidambaram has been mentioned as an alternative to Rahul, potentially in a power-sharing arrangement between Sonia Gandhi and Manmohan Singh, especially if Congress can only form a weak government.

DEFENCE, WEAPONS IMPORTS

The worst fighting between India and Pakistan in the disputed Kashmir region for almost a decade struck in early January when two soldiers from each side were killed, and the Indian army chief accused Pakistani soldiers of beheading one of the victims.

Any violence between the nuclear-armed neighbours always sparks concern, particularly in a region which has been the casus belli for two wars since 1947, and the January flare-up came after tensions at the Kashmir frontier, known as the Line of Control, had been rising for months.

Though those killings have not led to larger battles, more outbursts of violence are not impossible, and it takes political skill to defuse incidents.

India, the world's largest weapons importer, earlier this year suspended a deal for $750 million worth of helicopters it had ordered from Finmeccanica SpA pending an inquiry into allegations the manufacturer paid bribes to clinch the contract.

If the deal is cancelled on the basis that illegal payments were made through a middleman, it could jeopardise other contracts. The biggest deal on the table is for 126 fighter jets, expected to cost upwards of $10 billion.

India is currently in exclusive talks with France's Dassault for those jets. The defence ministry says it is too early to say if there are any problems with that deal, and expects to finalise negotiations this year. If the deal were for any reason scrapped, a new tender would likely have to be issued.

Number two contender, the Eurofighter consortium, could possibly enter exclusive talks with India if Dassault fails to reach a price agreement with the government.

What to watch:

- Any further violence in Kashmir, and how the Indian and Pakistani governments respond.

- Outcome of the investigation into the Finmeccanica helicopter deal, and whether other arms contracts are reviewed.

(Editing by Daniel Magnowski)