Prime Minister Manmohan Singh will hold off on widely anticipated fuel subsidy and retail reforms because of renewed opposition from party colleagues and coalition allies, leaving budget targets in tatters and rattling investors.
Members of Singh's Congress Party and senior government officials said that no movement was expected until at least the second week of September, despite market expectations of an announcement this week or the next.
Despite consultations with partners and state governments, it was not clear how Singh would be able to build a consensus on opening the $450 billion retail sector to foreign supermarkets like Wal-Mart Stores or on increasing fuel prices.
"Such an announcement will not be made unless a political consensus is reached," one party leader said.
The rupee fell for a fourth successive session on Wednesday on growing worries of government dithering on policy reform.
A month-long session of parliament starts on August 8. While the government does not need parliamentary approval for the reforms, many Congress politicians said the party would find it hard to stomach protests from allies and the opposition.
Singh took over the finance ministry portfolio after Pranab Mukherjee resigned in June to contest and later win election to the largely ceremonial role of the nation's president.
Singh, the architect of India's initial economic reforms in the 1990s, promised to revive the 'animal spirit' of the economy and many investors had expected him to move in the period between Mukherjee's election on July 19 and the opening of what is dubbed as the monsoon session of parliament.
Changing rules to allow multi-brand foreign retailers to operate in India was expected to be the first major announcement. But that plan hit fresh opposition from the Samajwadi (Socialist) Party, a major Congress ally, and left parties last weekend.
"We urge the government not to open up the retail trade to FDI (foreign direct investment) any further," Samajwadi leader Mulayam Singh Yadav and communist party leaders told Singh in a letter that was published in Indian newspapers.
Shares of retailers fell as much as 7 percent after the contents of the letter were made public.
Singh had introduced the retail reform plan last year but quickly abandoned it after protests in parliament and on the street.
The plan to reduce subsidies on diesel, kerosene and cooking gas, that are aimed at India's poor and rural majority, also looks in trouble because crop yields this year could be affected by poor rains.
Most Indians work in agriculture and political parties are loathe to hurt their pockets, especially since inflation has run at over 7 percent for two years.
Singh's office said this week that the rains in the June-September monsoon season that irrigate 55 percent of India's farmlands were likely to be below average. The season accounts for 75 percent of the country's annual rainfall and half of that is usually delivered in June and July.
The oil ministry indicated this week that diesel prices wouldn't be raised before September, and unlikely to cover the subsidy, putting more pressure on the budget.
ALREADY SPENT
A senior finance ministry official told Reuters delays to reforms, especially raising heavily-subsidised fuel prices, meant India would struggle to meet the fiscal deficit target of 5.1 percent of the budget, or $91.4 billion.
The government has already spent most of the $7.6 billion set aside for fuel subsidies in the 2012-13 fiscal year. To make matters worse, demand for diesel is expected to rise as farmers try to cope with poor monsoon rains by pumping more from wells.
Subdued tax income and hiccups in plans to sell stakes in state-run companies are adding to pressure on the budget and subsidies for food are als rising, leading the government to mull asking for $5 billion-$7 billion beyond budgeted subsidy spending, the official said.
The poor monsoon and dampened investor sentiment means growth, which was at its lowest in nine years in the March quarter, is unlikely to rebound any time soon.
Another senior official at the finance ministry said the 2012-13 (April-March) growth target of 7.6 percent will be revised downward 'significantly' and blamed flat industrial output, and slowdowns in exports and the information technology in the first quarter.
"It is an exceptionally difficult year," the official said.
"Oil prices are stuck at a high level, the current account deficit is still large enough that capital inflows are not bouncing back, so it will be difficult for us to do significantly better," he said.
The RBI has already revised down its growth target for the year.
Ratings agency Standard & Poor's said last month that political obstacles to economic policy meant India risked losing its investment grade sovereign debt rating.
"The market is ready to give Prime Minister Manmohan Singh the benefit of doubt for a couple of months," said Jagannadham Thunuguntla, strategist and head of research, at SMC Global Securities Limited.
"If there is no action in terms of reforms like FDI in multi-brand retail or diesel price hike, equity markets would fall at least 10-15 percent from the current levels," he said.