Outlook for 2011-15

• Despite its lack of a reliable parliamentary majority, the Indian National Congress-led United Progressive Alliance coalition government is expected to serve its full second term to 2014.
• Political stability will vary from one region of India to another. The violent insurgency waged by Naxalite (Maoist) groups across large swathes of central and eastern India is becoming the country's most serious security problem.
• Economic reform will continue only incrementally. The government is likely to restrict its focus to targeted spending and piecemeal changes, rather than attempting to implement more sweeping structural reforms.
• The Economist Intelligence Unit expects the government to meet its budget deficit target of 5.5% of GDP for fiscal year 2010/11 (April-March). Public expenditure will continue to rise rapidly in 2011-15.
• The Reserve Bank of India (RBI, the central bank) will continue to tighten monetary policy in 2011, raising the benchmark repurchase (repo) rate to 6.5%. Monetary policy will return to a more neutral setting in 2012-15.
• Real GDP on an expenditure basis is forecast to expand by 9.1% in 2010/11 and 8.9% in 2011/12, compared with 7.7% in 2009/10. Growth will average 8.7% a year in the period from 2012/13 to 2015/16.

Monthly review

• State assembly elections in Bihar have resulted in a victory for the existing government there. The biggest loser was Congress, which won just four seats, down from nine in the previous state election.
• Congress is facing an internal crisis, following the resignation from the party of the head of a powerful business and political family in the southern state of Andhra Pradesh.
• In its mid-quarterly review of monetary policy on December 16th, the RBI kept key interest rates unchanged but lowered the statutory liquidity ratio by 1 percentage point, to 24%.
• The government has postponed until 2011/12 the follow-on public offering of shares in state-owned Indian Oil, the country's largest refiner and marketer of petroleum.
• The Indian economy (measured at factor cost) grew at the unexpectedly rapid pace of 8.9% year on year in July-September.
• Industrial output soared by 10.8% year on year in October as demand for consumer durables (such as cars and electronic goods) and power equipment picked up.

The Indian National Congress-led United Progressive Alliance (UPA) coalition government, led by the prime minister, Manmohan Singh, can take credit for India's strong economic recovery following the 2008-09 global recession. However, the UPA administration's achievements on the political front have been far less impressive. Hopes that the government would be more effective in its second term (2009-14) than during its first (2004-09) have been shown to be overly optimistic, as indicated by the difficulty that the UPA has faced in passing important legislation. The ruling coalition has been hindered in this regard by the fact that it lacks a reliable working majority in the Lok Sabha (the lower house of parliament) and is in a minority in the Rajya Sabha (the upper house). Moreover, internal differences within the coalition will continue to hinder the government's reform efforts. The recent proliferation of corruption scandals is also likely to weaken the UPA's position during the remainder of its term, as it has undermined confidence in the government.

Mr Singh's government faces several challenges during the remainder of its second term, including bringing down inflation, delivering more decisively on its promise of inclusive economic growth, dealing with an escalating Maoist insurgency in eastern and central India and managing the uprising in the troubled region of Kashmir. Each of these challenges is substantial, and the government is likely to continue to achieve greater success in the economic sphere than in the sociopolitical realm.

Although making more demonstrable progress on fighting corruption has long been a problem for the government, the recent spate of scandals-and most notably that relating to the sale of second-generation (2G) telecommunications licences in 2008-has put a renewed spotlight on the challenge of reducing graft. On the one hand, the government seems acutely aware of the extent to which corruption hurts its international reputation. For example, the chief minister of Maharashtra, Ashok Chavan, was forced to step down in response to a corruption scandal, but because he had welcomed the US president, Barack Obama, to India in November (Mr Obama's first stop was Maharashtra's capital and India's main financial centre, Mumbai), he was not sacked until after Mr Obama had left the country. On the other hand, Mr Singh's reluctance to investigate the telecoms-licence auction sooner is evidence that the government is concerned primarily with keeping the ruling coalition together. The need to focus on governmental stability, potentially at the expense of policy and even ideology, is directly related to the rise of regional and caste-based parties in the past three decades. Alliance-building on the basis of political opportunism rather than shared policy goals creates inherently fragile governing coalitions, and this factor will remain a potential source of political instability in the forecast period (2011-15), as the UPA will remain unable to govern without the support of regional and caste-based parties.

Political stability will vary from one region of India to another. The violent insurgency waged by Naxalite (Maoist) groups across large swathes of central and eastern India is becoming the country's most serious security problem. The government is reviewing its counter-insurgency strategy, but the grievances that motivate the insurgents will take years to resolve. The Maoists operate in India's poorest states, and economic inequalities and land disputes are adding to their ranks. The violence is likely to worsen in 2011-15, and the Maoist threat is on course to eclipse even friction with Pakistan as the Indian security establishment's biggest concern. Other remote areas will also witness continued conflict. Guerrilla groups operate in most states in north-eastern India, seeking secession or demanding their own states. In addition, the security situation in the Indian-administered part of Kashmir has deteriorated markedly since July and will remain volatile.

India faces both domestic and foreign terrorist threats. Further terror attacks could occur in 2011-15, exacerbating domestic sectarian conflict and tensions with Pakistan. Political fragmentation and anti-government violence present serious challenges, but India's democratic institutions are firmly entrenched and resilient, with orderly and generally accepted transfers of power. The risk of political collapse is thus much lower than in most other developing countries in Asia.

The UPA does not face any immediate electoral threat, and the Economist Intelligence Unit still expects it to complete its current five-year term. Mr Singh will continue as prime minister for the time being, although it is likely that Congress leaders will eventually clear the way for Rahul Gandhi, the son of the party's president, Sonia Gandhi, to take over. The next general election must take place by May 2014 and is all but certain to result in another coalition government.

India's schedule of state assembly elections resumed in October, with the six rounds of voting in the state of Bihar completed on November 20th. Congress performed poorly in the poll, losing five seats in the state legislature. The biggest electoral prize, however, is Uttar Pradesh, India's most important state politically. Assembly polls there are not due until 2012. The Bharatiya Janata Party (the main opposition party at national level) and the Samajwadi Party are in decline in the state. Congress, which has not been a significant force in Uttar Pradesh since the early 1990s, hopes to regain power there or at least to come second behind the Bahujan Samaj Party.

India's relationship with Pakistan will remain strained, despite the resumption in April 2010 of the formal peace process, which had been suspended since the November 2008 terrorist attack on Mumbai. Indian disquiet about crossborder terrorism has been one of the main obstacles to efforts to improve bilateral ties, and India remains concerned that Pakistan has acted with insufficient urgency against those that India believes to have been responsible for the Mumbai attack. Progress on bridging the "trust deficit" between the two countries will be slow, and if India suffers another terrorist attack linked to Pakistan relations will deteriorate again.

Relations between India and China will remain tense and problematic. In mid-December China's prime minister, Wen Jiabao, made a three-day state visit to India. The trip was a success in commercial terms, as the two sides reportedly signed business deals worth some US$16bn. However, rising strategic tensions stand in the way of significantly warmer ties between Asia's two aspiring great powers. Incursions by Chinese troops into areas disputed with India will complicate the resolution of long-running border disagreements between the two countries. China has started to issue special visas to Indian citizens from two states, Arunachal Pradesh and Jammu and Kashmir, thereby implying that residents there have a different status from other Indian nationals), and India has introduced tighter visa requirements for Chinese workers. China claims part of the Indian-administered section of Kashmir, while India says that China is illegally occupying part of its territory. India also objects to Chinese-funded infrastructure projects in the Pakistani-administered part of Kashmir and is worried about China's military build-up in Tibet. These issues are likely to overshadow attempts to build mutual confidence and expand bilateral trade in 2011­15.

The continuance of Congress as the main governing party following the 2009 general election means that macroeconomic policy in the forecast period will be consistent with the direction pursued in the first five years of UPA rule. The budget for fiscal year 2010/11 (April-March), which was unveiled in February 2010, contains plans for tax reforms, consolidation of the public finances and a reduction in fiscal stimulus measures in the medium term. Monetary tightening will continue into early 2011. Priority will continue to be given to populist measures designed to help the aam admi (common man). The concept of "inclusive growth" will remain central to government policy.

Congress's more dominant role in the governing coalition following the 2009 general election, thanks to a rise in the level of electoral support for the party, initially raised the possibility that economic reform might move higher up the agenda. The party's electoral mandate gives Mr Singh the ability to push for reform more effectively, but its lack of a reliable parliamentary majority means that the most likely scenario in the forecast period is the continuance of merely incremental reform, with the government focusing on areas where changes can be made without legislative action. Moreover, resistance to reform persists in the ruling party and among its core supporters, particularly in rural areas. For the most part, therefore, the government is likely to restrict its focus to targeted spending and piecemeal changes, rather than attempting to implement structural reforms that would unlock more of India's vast economic potential.

The 2010/11 budget includes a strong emphasis on fiscal consolidation. It outlines a schedule of progressive deficit reduction, according to which the budget shortfall is targeted to narrow to 5.5% of GDP in 2010/11, 4.8% in 2011/12 and 4.1% of GDP in 2012/13. The improvement in the fiscal position will be partly a function of faster economic growth. The other main factors contributing to the shrinking of the deficit until 2012/13 will be the proceeds from the government's divestment of shares in state-owned firms and auctions of third-generation (3G) telecoms licences, together with reforms to the fuel-subsidy programme. Moreover, for the first time ever the budget includes an explicit target for a reduction in the ratio of public debt to GDP. We forecast that the government will achieve its budget deficit target for 2010/11. The Ministry of Finance has said that the government stands a good chance of beating the target, given the success of the 3G auction and the strength of tax revenue in the first quarter of 2010/11. Although we acknowledge that this is possible, we believe it more likely that the government will use any unexpected fiscal flexibility to fund its myriad welfare schemes. The budget deficit will shrink further in 2011/12, but at 5.1% of GDP it will miss the government's target by a narrow margin. Public expenditure is expected to continue to rise rapidly in the remainder of the forecast period, as the government has announced large increases in spending on health, education and rural infrastructure. However, rapid economic growth will allow the budget deficit to continue to fall steadily as a percentage of GDP during 2011-15.

The Reserve Bank of India (RBI, the central bank) has been tightening monetary policy since January 2010 in response to stubbornly high inflation. There were five increases in 2010 in the repurchase (repo) rate (the interest rate at which the RBI adds funds to the banking system), the most recent of them in early November; the repo rate now stands at 6.25%. We forecast that the repo rate will rise to 6.5% by the end of 2011. Assuming that the current inflationary surge abates, this will be sufficient to turn real interest rates positive. However, the RBI will remain mindful that higher interest rates could undermine the government's fiscal consolidation plan, encourage volatile capital inflows and exert upward pressure on the value of the rupee. Monetary policy will return to a more neutral setting in 2012-15.

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On the basis of unexpectedly strong national-accounts data for July-September, we have revised up our forecast for growth in real GDP (on an expenditure basis) to 9.1% (from 8.8% previously) in 2010/11 and to 8.9% (8.6% previously) in 2011/12. Real GDP growth is then forecast to average 8.7% a year in the period from 2012/13 to 2015/16. India's strong growth fundamentals-high saving and investment rates, fast labour force growth and the rapid expansion of the middle class-will ensure a steady performance, with little volatility in growth rates from year to year. But despite India's current impressive growth performance, there are a number of clouds hanging over the economy, including the stubbornly high inflation rate and the wide (albeit narrowing) budget deficit. It is for these reasons that we do not expect the government's GDP growth target (on a factor-cost basis) of 10% in 2011/12 to be achieved. Growth will continue to be constrained by infrastructure bottlenecks, shortages of skilled labour and the difficulties involved in shifting resources from low-productivity agriculture to higher-productivity manufacturing. However, India has huge scope for catch-up growth, not only with developed countries but also with other emerging markets.

Economic growth will be led by private investment and government spending in the next five years. Private consumption will not grow as fast as the overall economy, and net exports are forecast to exert a slight drag on GDP growth as imports are sucked in to satisfy rapidly growing domestic demand. Growth will continue to be led by services and industry, while the agricultural sector and its reliance on monsoon rains poses a downside risk to the rate of economic expansion. The possibility of a reversal of capital inflows, which have been financing India's persistent current-account deficit, also represents a downside risk-one that has risen in prominence since the EU sovereign debt crisis deepened in mid-November. Another downside risk to our forecast for buoyant economic growth is any further increase in commodities prices, which would cause the current-account deficit to widen.

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After peaking at over 16% in January 2010, the annual rate of consumer price inflation moderated to 9.8% in October in response to tighter monetary policy and slower food price inflation. Consumer price inflation will decelerate in 2011, to an average of 6.8%, from an estimated 11.9% in 2010. In 2012-15 consumer prices will rise by 5-6% a year, assuming the absence of shocks such as a sharp rise in commodity prices or a failure of the monsoon in any given year. Another factor that could increase inflationary pressures is the deregulation of fuel prices. In June the government decided to end state control of petrol and diesel prices in an effort to bolster the public finances. The relaxation of price controls is a crucial step towards reducing losses at India's public-sector oil companies and containing the government's rising contingent liabilities. Our benign outlook for global oil prices suggests that the government will be able to eliminate fuel subsidies entirely during the forecast period, but a surge in petroleum prices would quickly feed through to domestic fuel costs. It is also possible that the government could reimpose prices controls in the event of another oil price shock.

The rupee is forecast to appreciate slightly during the forecast period, from an estimated average of Rs45.7:US$1 in 2010 to Rs42:US$1 in 2015. The currency's strengthening will be driven primarily by strong inflows of foreign investment, attracted by India's bright economic prospects. The current-account deficit is not expected to pose a threat to the rupee, given that it is forecast to average a moderate 1.9% of GDP during the forecast period. Given India's high estimated average rate of inflation in 2010 and the fairly rapid rate of price increases forecast for 2011-15, the rupee's nominal strengthening will represent a substantial appreciation in real terms, amounting to nearly 30% in the period.

Although the rupee is currently under upward pressure, it is also vulnerable to a number of downside risks. It will continue to be exposed to the inherent volatility of portfolio investment inflows. A bout of the jitters on the part of foreign investors could trigger a sharp fall in the rupee's value and could easily wipe out the modest gains that the currency is expected to make in 2011-15. The rupee could also be susceptible to downward pressure on its value if inflation runs out of control or the government fails to enforce greater fiscal discipline.

The current-account deficit is forecast to remain fairly steady as a share of GDP in the forecast period, at around 2%. Substantial capital inflows will ensure that the shortfall on the current account poses little risk to the economy, and India will continue to accumulate foreign-exchange reserves. Merchandise exports and imports will both expand rapidly in 2011-15: exports will grow at an average annual rate of 12.4%, while imports will rise by 13.2% a year. As a result, the trade deficit will widen to US$264.9bn in 2015, from an estimated US$135.3bn in 2010. Strong growth in merchandise exports and imports in the five-year period will reflect not only robust economic growth but also the further opening of the local economy to international trade and global production systems. The expansion of the country's manufacturing capacity will boost its export performance as well as leading to increased demand for raw materials, while booming domestic demand will sustain rapid growth in imports of consumer goods.

Services exports will continue to play a vital role in the country's external trade as information technology (IT) and business-process outsourcing continue to lure Western companies to India. Having built up supplier relationships, India's IT companies are expected to continue to grow rapidly, and the most sophisticated of them will continue to move up the value-added chain. Services exports are forecast to grow by 20% a year on average in 2011-15, enabling the services surplus to increase to almost US$159.1bn by 2015, when the value of services exports will be equivalent to around three-quarters of revenue from merchandise exports. The income deficit, which is small at present, will widen steadily to over US$40bn in 2015, reflecting an increase in the repatriated profits of foreign companies operating in India. The current transfers balance will stay positive, rising to US$108.7bn in 2015, driven by strong growth in remittances from Indian workers overseas.

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The state assembly election in the eastern state of Bihar in October-November resulted in a landslide victory for the existing government, a coalition led by the Janata Dal (United), or JD (U)-led by the chief minister of the state, Nitish Kumar-and the Bharatiya Janata Party (BJP). The coalition won 206 seats in the 243-strong assembly. The main opposition parties, the Rashtriya Janata Dal (RJD) and the Lok Janshakti Party, won a total of 25 seats between them.

The biggest loser was the Indian National Congress party, which won just four seats, down from nine at the previous state election. The party's hopes of regaining the ground that it has lost to the BJP and to various regional and caste-based parties in the past 25 years were not fulfilled. Rahul Gandhi, the son of the Congress party president, Sonia Gandhi, campaigned hard but failed to turn the party's fortunes around. At national level, Mr Gandhi is still tipped to be Congress's next prime ministerial candidate. The litmus test for his ambitions will be the state assembly election this year in the northern state of Uttar Pradesh, the political home of the Gandhi dynasty (both Mr Gandhi's and his mother's constituencies are in Uttar Pradesh) and India's biggest and politically most important state. There is little doubt that Mr Gandhi would become prime minister in the future were Congress to win a majority there, as such a victory would deliver a powerful boost to his credentials and credibility.

The BJP was pleased with its performance in the Bihar poll, in which it won 81 seats, but without the JD(U), its popular coalition partner, it would not have done so well. The election result was seen as a vote for development and improved governance-Mr Kumar's main campaign issues, and areas in which his government achieved success during its previous term. The public works programmes, upgraded transport infrastructure, and improved law and order that the coalition in Bihar has delivered have proved popular. This is in sharp contrast to the previous 15 years, during which the RJD's Lalu Prasad Yadav and later his wife, Rabri Devi, ruled the state as their personal fiefdom, promising empowerment for backward classes but doing little in practice to improve the welfare of the local population. Mr Kumar's victory does not necessarily mean an end to the politics of caste, although some commentators have suggested that this could happen. Since coming to power in Bihar the JD (U) has introduced "reservations" (essentially, quotas) for minority and underprivileged groups and has targeted welfare measures towards so-called backward communities.

Congress is facing political difficulties following the resignation from the party in late November of Jaganmohan Reddy, the head of a powerful business and political family in the southern state of Andhra Pradesh. Mr Reddy, who is the son of a past chief minister of the state, Y S Rajashekhara Reddy, said that he intended to launch a party of his own. The move followed months of in-fighting and Mr Reddy's failed attempt to become chief minister of Andhra Pradesh. It is rumoured that his new party, once formed, could ally itself with the BJP-led National Democratic Alliance coalition at national level. Such a development would be a major blow for Congress. The Reddy family has made an important contribution to Congress's success in Andhra Pradesh. In the 2009 general election Congress won 33 seats there, more than in any other state.

The Economist Intelligence Unit's 2010 democracy index ranks India 40th out of 167 countries, putting it among the 52 countries considered to be "flawed democracies". This designation includes neighbouring countries such as Sri Lanka, Thailand, the Philippines, Indonesia and Malaysia, as well as another emerging-market giant, Brazil. However, India is highly placed within this category, ranking above all of these countries. Its relatively strong position owes much to its high scores in the electoral process and pluralism and civil liberties categories; its status as the world's largest democracy, and the country's vibrant free press and pluralistic society, have long been justly celebrated. In these areas India outscores even some long-established democracies that we designate "full democracies", including the US and the UK.

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Political culture has become even weaker

However, India fares much worse in the political participation and political culture categories. The phenomenon of the "argumentative Indian" may facilitate public debate, but this does not necessarily translate into a high level of political participation. Voter turnout in the most recent general election, in April-May 2009, stood at 57%, but this figure masks wide variations between different parts of the country, ranging from a turnout figure of 90% in the small north-eastern state of Nagaland to just 46% in Uttar Pradesh, India's largest and most politically influential state. However, it is the significant decline in the score for political culture, to 4.38, from 6.25 in our 2008 index, that bears greatest responsibility for India's lower overall score of 7.28 out of 10 in the 2010 index (compared with 7.8 in the 2008 index). This in turn helps to account for the fact that India's global ranking in the index is now five places lower than it was in the 2008 index. The political culture category incorporates less tangible indicators of the foundations for democracy, including the population's perceptions of, and desire for, rule by the military or by technocrats rather than by an elected government. India's relatively poor score in this category probably reflects the impatience of at least some segments of society with the country's cumbersome, slow-moving system of government and their desire for a potentially more efficient form of leadership. This is particularly noteworthy given that comparisons continue to be made between the economic growth rates and prospects of India and China: debate still flourishes about whether the ability of China (which is categorised as an "authoritarian regime" in our index) so far to achieve faster rates of economic growth than India owes at least something to the fact that it is non-democratic and therefore perhaps more efficient. India's score for government functioning is fairly high but is constrained by lingering issues relating to corruption and government accountability. Moreover, the country's continuing reliance on governments consisting of unwieldy and sometimes unco-operative coalitions often hinders rather than advances economic reforms, and this works against India's overall score.

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Democracy index 2010: Democracy in retreat, a free white paper containing the full index and detailed methodology, can be downloaded from www.eiu.com/DemocracyIndex2010.

Note on methodology

There is no consensus on how to measure democracy, and definitions of democracy are contested. Having free and fair competitive elections, and satisfying related aspects of political freedom, is the sine qua non of all definitions. However, our index is based on the view that measures of democracy which reflect the state of political freedom and civil liberties are not "thick" enough: they do not encompass sufficiently some crucial features that determine the quality and substance of democracy. Thus, our index also includes measures of political participation, political culture and functioning of government, which are, at best, marginalised by other measures.

Our index of democracy covers 167 countries and territories. The index, on a 0-10 scale, is based on the ratings for 60 indicators grouped in five categories: electoral process and pluralism; civil liberties; functioning of government; political participation; and political culture. The five categories are interrelated and form a coherent conceptual whole. Each category has a rating on a 0-10 scale, and the overall index of democracy is the simple average of the five category indices.

The category indices are based on the sum of the indicator scores in the category, converted to a 0-10 scale. Adjustments to the category scores are made if countries fall short in the following critical areas for democracy:

• whether national elections are free and fair;
• the security of voters;
• the influence of foreign powers on government; and
• the capability of the civil service to implement policies.

The index values are used to place countries within one of four types of regime:

• full democracies-scores of 8 to 10;
• flawed democracies-score of 6 to 7.9;
• hybrid regimes-scores of 4 to 5.9;
• authoritarian regimes-scores below 4.

The Reserve Bank of India (RBI, the central bank) has been working to contain liquidity problems in the banking system. The RBI introduced a series of measures after banks' daily borrowing from the central bank's repurchase (repo) auctions rose to around Rs1trn (US$22bn) in November. In its mid-quarterly review of monetary policy on December 16th the RBI kept key interest rates unchanged but reduced the statutory liquidity ratio (the percentage of deposits that banks are mandated to keep in the form of government securities) by 1 percentage point, to 24%, with effect from December 18th in a bid to inject liquidity into the system. The liquidity constraints are the result of tighter monetary conditions in an economy that has been growing at a rate close to or above its non-inflationary potential. The cash crunch was expected to worsen as companies readied themselves to pay the third instalment of their advance tax, estimated at US$11.1bn in total, by the deadline of mid-December.

The government has postponed until fiscal year 2011/12 (April-March) the follow-on public offering of shares in state-owned Indian Oil, the country's biggest petroleum refiner and oil-marketing company. The government, which holds a 78.9% stake in Indian Oil, had planned to sell a 10% stake by the end of January 2011. It cited the recent surge in oil prices as the main reason for the postponement: downstream oil-marketing companies in India tend to lose money when crude oil prices climb. For the government, which operates a fuel-subsidy regime, state-owned firms such as Indian Oil are instrumental in keeping retail energy prices artificially low. Given that inflation is still a major concern, these companies-despite a partial deregulation of fuel prices in June-are not allowed by the government to raise prices in line with international price increases.

The proceeds from the share sale, estimated at Rs200bn (US$4.4bn), were to be used to revive a shelved petrochemicals project in Paradip, in the state of Orissa, and to build a gas-importing facility at Ennore, in Tamil Nadu. The revenue would also have allowed the government to reach its target of Rs400bn from part-privatisations of state-owned enterprises in 2010/11. In the first nine months of 2010/11 it raised more than Rs200bn from such divestments, the two largest being sales of 10% stakes in Coal India (bringing in Rs152bn) and Power Grid (realising Rs74bn). The government now intends to sell a 5% stake in the Oil and Natural Gas Corporation (ONGC), a state-owned upstream oil company (which, unlike India's downstream operators, tends to benefit from rising international crude oil prices). The cabinet approved the share offer on December 1st. The sale will reduce the government's stake in ONGC to 69.1% and is expected to raise Rs110bn-130bn. The fate of other proposed part-privatisations, including follow-on public offerings in the Steel Authority of India and Hindustan Copper, is unclear.

The government has come under pressure to recoup some of the losses that it incurred as a result of the corrupt sale of second-generation (2G) mobile-phone licences in 2008. The corruption scandal came to light in November 2010. According to the Comptroller and Auditor General, the revenue lost through the sale of licences at sub-market prices has been estimated at a staggering US$39bn. The Telecom Regulatory Authority has recommended revoking 38 permits for wireless spectrum and has suggested the "legal examination" of another 31 licences. In total, 157 licences were sold in 2008, mostly to ineligible bidders at, "unbelievably low" prices, according to the Comptroller and Auditor General.

The regulator has the legal power to revoke licences. Few of the successful bidders, which include both large domestic and international operators, will be able to claim credibly that the process was not flawed, and lengthy legal battles could therefore result. Potential investors in India will have to trust that the 2G case is atypical and that they will not be forced to pay retroactively in situations where the government may find that correct procedures have not been followed. Still, the issue could damage India's reputation as an investment destination.

The Indian economy (measured at factor cost) grew at an unexpectedly rapid pace in July-September 2010, expanding by 8.9% year on year. The Central Statistical Office has also revised up real GDP growth in April-June by 0.1 percentage points, to 8.9%. This means that the economy expanded by 8.9% year on year in the first six months of 2010/11-a much faster rate than that of 7.5% in the year-earlier period.

National-accounts data for the second quarter of 2010/11 reveal three main points. First, economic growth was driven by a rapidly expanding services sector: services contributed nearly 6 percentage points to GDP growth. Second, growth in manufacturing activity slowed, to stand at 9.8% year on year, down from 13% in April-June. (Manufacturing contributed about 1.5 percentage points to GDP growth.) Finally, at an annual rate of 4.4% growth in the agricultural sector was twice as fast as in previous quarters and well above its long-term average rate. The strong performance of the farming sector owed much to a low base of comparison, as agricultural production in July-September 2009 was adversely affected by the poorest monsoon rains in nearly four decades.

Data on the expenditure side confirm the surge in economic activity in July-September. Private consumption and government consumption rose by 9.3% and 9.2% respectively. Investment growth also remained strong, at 11.1% year on year, although this was down from 19% in April-June. Overall, real GDP growth on an expenditure basis was 10.6% year on year.

Following the release of these strong national-accounts data for the second quarter of the current fiscal year, the government has revised up its forecast for GDP growth in 2010/11 as a whole. It now believes that the economy could grow by 9% in the fiscal year; this would be the highest rate of growth in three years. But the Ministry of Finance, in the mid-year analysis of the economy that it presented to parliament, also said that average inflation (as measured by the wholesale price index) would be far higher than the target of 5.5% set by the RBI for 2010/11, at 9%. Average food price inflation is forecast by the ministry at 20%. This is a worry for the government, as prices for basic food items are always a major issue with voters.

The most recent economic data releases suggest that economic activity has gathered further momentum in October-December. The purchasing managers' index (PMI) compiled by a UK-based bank, HSBC, has reached its highest level since May 2010, rising from 57.2 points in October to 58.4 in November. The survey, which covers 500 companies, also showed a further rise in input prices and a pick-up in orders from overseas.

Meanwhile, activity in the services sector surged to a four-month high in November, according to HSBC's Services PMI. The Business Activity Index rose to 60.1 in November, from 56.2 in October, driven by new orders. On the consumer side, there are few indications that the steady tightening of monetary policy that has been implemented since the start of 2010 has curtailed spending (although interest rate rises tend to take effect with a significant lag, meaning that the impact of monetary tightening is likely to become evident only in coming months). Domestic car sales, for example, jumped by 21% year on year to 161,497 units in November, according to the Society of Indian Automobile Manufacturers. Sales of commercial vehicles, which can be taken as a proxy indicator of investment activity, meanwhile jumped by 18% year on year, to 48,314 units.

Industrial output soared by 10.8% year on year in October as demand for consumer durables (such as cars and electronic goods) and power equipment picked up. The jump followed a slide in annual industrial production growth in August-September. The government has said that it expects industrial output growth to be in double digits in 2010/11 as a whole. In April-October factory output (as measured by the industrial production index) was up by 10.3% year on year.

Manufacturing sector output grew by 11.3% year on year in October (compared with 10.8% a year earlier), while electricity production jumped by 8.8% (compared with 4% in October 2009). Mining output growth, however, slowed to 6.5%, from 9.1% in October 2009. Output of capital goods surged by 22% in October, up from 10.9 % in the same month in 2009. The data were in line with a gauge of six major industries which showed that activity was up by 7% year on year, a seven-month high, in October. The performance of the six core industries-crude oil production, petroleum refining, coal, electricity, cement and finished steel-is considered an advance indicator of industrial activity. The strong overall performance was driven by a 16.8% increase in cement output and a 6.2% rise in production of finished steel.

According to preliminary data, the value of India's merchandise exports rose by 26.8% year on year to US$18.9bn in November, while imports expanded by 11.2% to US$27.8bn. The trade deficit in November stood at US$8.9bn, compared with US$9.7bn in October; the trade deficit had reached its widest point for 23 months, at US$13.1bn, in August. The government has said that the shortfall on trade could reach US$135bn in 2010/11-an increase on the previous forecast of US$120bn.

Montek Singh Ahluwalia, the deputy chairman of the Planning Commission (the government's main economic policymaking body), has said that the economy can cope with a current-account deficit equivalent to 3-3.5% of GDP. There is a risk, however, that the deficit could widen significantly, as domestic demand strengthens and external demand remains vulnerable to a possible economic slowdown in the US and the EU. The problem is that at present nearly 80% of the current-account deficit is being funded by short-term capital inflows rather than more durable foreign direct investment. The major risk in this regard is therefore a reversal of capital flows. For example, a renewed global economic recession or a further deepening of the sovereign debt crisis in the euro zone might trigger an extended period of elevated risk aversion on the part of international investors that could lead to a sell-off of the rupee and of local bonds and equities, causing a liquidity crunch. This in turn would result in a sharp decline in output, similar to that which occurred in the wake of the 2008-09 global financial crisis and economic recession.

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Please see graphic below

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Please see graphic below

Land area

3,287,263 sq km (including Indian-administered Kashmir); of the total, 57% is agricultural land and 16% is forest area

Population

1.13bn (mid-2007)

Main towns

Population in millions, 2001 census

Mumbai (Bombay) 16.4

Kolkata (Calcutta) 13.2

Delhi 12.8

Chennai (Madras) 6.4

Bangalore 5.7

Hyderabad 5.5

Climate

Varied; humid subtropical in Ganges basin, semi-arid in the north-west, tropical humid in north-east and most of the peninsula, tundra in the Himalayas; all areas receive rain from the south-west monsoon in June-September; the south is also served by the north-east monsoon in January-March

Weather in New Delhi (altitude 218 metres)

Hottest month, May, 26-41°C (average daily minimum and maximum); coldest month, January, 7-21°C; driest month, November, 4 mm average rainfall; wettest month, July, 180 mm average rainfall

Languages

Hindi is the national language and the primary tongue of 30% of the population. There are 14 other official languages: Bengali, Telugu, Marathi, Tamil, Urdu, Gujarati, Malayalam, Kannada, Oriya, Punjabi, Assamese, Kashmiri, Sindhi and Sanskrit. English is widespread in business circles and as a second language

Religions

Hindu (80.5% in 2001 census); Muslim (13.4%); Christian (2.3%); Sikh (1.9%); Buddhist (0.8%); Jain (0.4%)

Measures

Metric system. Numbers are often written in lakhs (100,000) and crores (10m)

Currency

Rupee (Rs); Rs1 = 100 paisa. Average exchange rate in 2009: Rs48.4:US$1

Fiscal year

April 1st-March 31st

Time

5 hours 30 minutes ahead of GMT

Public holidays

Republic Day (January 26th); Independence Day (August 15th); Mahatma Gandhi's birthday (October 2nd); also major Hindu, Muslim, Christian and other religious holidays

Official name

Republic of India

Form of state

Federal republic, with 28 states and seven union territories

Head of state

The president, Pratibha Patil, was elected in July 2007 for a five-year term by the members of the central and state legislatures

The executive

The prime minister presides over a Council of Ministers chosen from the elected members of parliament

National legislature

Bicameral. The Rajya Sabha (the upper house) has 245 members-233 elected by weighted votes of the elected members of parliament and the legislative assemblies of states and union territories, and 12 appointed by the president. The Lok Sabha (the lower house) has 545 members-543 elected from single-member constituencies (79 seats are reserved for "scheduled castes" and 40 for "scheduled tribes"), and two representatives of Anglo-Indians appointed by the president

State legislatures

Unicameral or bicameral, with elected members; state governors are appointed by the president

Legal system

Based on the 1950 constitution and English common law

National government

The United Progressive Alliance (UPA), a coalition led by the Indian National Congress, won the largest number of seats in the April-May 2009 general election and formed a government

National election

The most recent Lok Sabha election was held in April-May 2009; the next is due by May 2014

Main political organisations

Indian National Congress; Bharatiya Janata Party (BJP); All India Trinamool Congress (TMC); Dravida Munnetra Kazhagam (DMK); Samajwadi Party (SP); Rashtriya Janata Dal (RJD); Janata Dal (United); Bahujan Samaj Party (BSP); All India Dravida Munnetra Kazhagam (AIADMK); Bijou Janata Dal (BJD); Nationalist Congress Party (NCP); Communist Party of India (Marxist), or CPI (M)

Prime minister: Manmohan Singh (Congress)

Key ministers

Agriculture, consumer affairs, food & public distribution: Sharad Pawar (NCP)

Commerce & industry: Anand Sharma (Congress)

Communications & information technology: Kapil Sibal (Congress)

Defence: A K Antony (Congress)

External affairs: S M Krishna (Congress)

Finance: Pranab Mukherjee (Congress)

Heavy industries & public enterprises: Vilasrao Deshmukh (Congress)

Home affairs: P Chidambaram (Congress)

Information & broadcasting: Ambika Soni (Congress)

Law & justice: M Veerappa Moily (Congress)

Petroleum & natural gas: Murli Deora (Congress)

Power: Sushilkumar Shinde (Congress)

Railways: Mamata Banerjee (TMC)

Road transport & highways: Kamal Nath (Congress)

Steel: Virbhadra Singh (Congress)

Central bank governor

Duvvuri Subbarao