By Krittivas Mukherjee
NEW DELHI, Feb 1 (Reuters) - The likely pace of economic reform remains the main political risk for India, given the ruling coalition's inability to take bold steps to further open up the economy despite last year's strong election victory. The spread of 5-year credit default swaps on ICICI Bank -- used as a proxy for Indian sovereign debt because of its better liquidity -- is around 181.50 basis points, compared to a weighted average of 134.40 for the Thomson Reuters Emerging Asia Index. The ICICI spread narrowed to around 165 last month, its lowest since the onset of the global economic crisis, but has since widened slightly. Following is a summary of key India risks to watch: * ECONOMIC REFORM While the government had appeared to be in a strong position to press forward with an ambitious economic reform agenda, progress has been much slower than some investors had hoped. The government has made headway in some areas: it has pledged to reform tax laws, disinvest in some 60 state-run firms and formed an experts panel to ease foreign investment in the financial sector -- steps markets would regard positively. [nSGE60D0F4] But the government is seen as repeatedly giving in to street protests -- such as demands for new states driven by ethnic and regional groups [nSGE5BD0FY] -- raising doubts about firm governance that is needed to quicken the pace of reform. The Congress party, which heads the coalition, is also seen as trying to balance the opinion of its many younger, reformist politicians against more traditional figures within the party who often focus more on political expediency. [nSGE60H07R] Expediency has meant that painful adjustments to freer markets, for instance labour reforms and deregulation of farm prices, have been shelved in the face of public pressure. What to watch: -- Markets will watch for moves to privatise some state firms, relax restrictions on foreign direct investment, ease restrictions on foreign banks, and reform labour laws. -- If investors conclude that the pace of reform will remain much slower than previously hoped, some of the gains in Indian markets since the last election will be retraced. Stocks in sectors affected by reform delays would be hardest hit. * INFLATION AND MONETARY POLICY Food prices are rising at an annual rate of nearly 20 percent in India and the government is struggling to find a solution. There have been several mass protests and the opposition has been making the most of the issue, but the Congress Party faces no risk of losing power any time soon. Tensions are emerging within the government, however, with Prime Minister Manmohan Singh recently berating his farm minister over food prices. Increasing hardship could spark social unrest. [ID:nSGE60H07R] Signs of tension between the government and central bank over the best policy balance have emerged, making monetary policy more difficult to forecast. The bank has been getting more hawkish on inflation while the government insists economic recovery must not be compromised. The central bank last week left rates unchanged but surprised markets with a 75 basis point rise in banks' reserve requirements, higher than expected. [ID:nSGE60O07O] What to watch: -- Comments by key government and central bank officials on the timing and scale of interest rate rises. If disagreements widen, the greater policy risk and inflation concerns would weigh on Indian debt prices . -- If food prices continue to stoke social discontent, the government may feel less inclined to push ahead with economic reforms, with a negative impact for Indian markets. * EXTERNAL SECURITY After a hint of recovery in their relations from the depths plumbed in the aftermath of the 2008 militant attack on Mumbai, tension is mounting again between India and Pakistan amid reports of near-daily border skirmishes. The diplomatic temperature has also risen over the rejection of Pakistani players in an auction of players for an Indian cricket tournament. Military conflict remains only a very slim possibility. But a limited confrontation cannot be ruled out if Pakistan-based militants once again launch a major attack on Indian soil, making India-Pakistan conflict an unpredictable risk. And Pakistan's weak government, under threat on several fronts, may have its own reasons to focus popular anger on India. [ID:nSGE60I04Z] Ties between India and China have soured with the resurgence of a long-festering border dispute in Arunachal Pradesh. Reports of border incursions sparked unease. India also balks at Beijing's support for projects in Pakistan-controlled Kashmir and a separate visa policy for Indian Kashmiris, which New Delhi sees as undermining its claim over the region. There is little chance of war between the two countries but further disputes could sour their booming trade relationship. [ID:nGEE5B71X0] What to watch: -- Progress on resuming substantive talks with Pakistan. India remains reluctant to make any concessions unless Pakistan does more to deal with those behind the Mumbai attacks. Any sign of rapprochement would be greeted positively by investors, but would not have a significant short-term market impact. * INTERNAL SECURITY The risk of violent attacks by domestic insurgent groups or foreign militants remains high. Al Qaeda and affiliated groups see India as a key battleground, and Pakistan is likely to remain a haven for militants seeking to launch attacks in India. Security forces are also battling a Maoist insurgency spreading across large swathes of countryside, much of it rich in minerals. What to watch: -- The danger of new attacks. Investors have priced in the threat level in India, as the muted market reaction to the Mumbai attacks showed, but attacks causing a serious deterioration in relations with Pakistan would be market-negative. [ID:nGEE5B5050] * TRADE AND PROTECTIONISM India will play a central role in determining whether the Doha round at the WTO can finally be concluded. The government's strong mandate and relatively secure position may allow it more flexibility in reaching agreement even if this is opposed by some powerful interest groups. But India continues to show an ambivalent attitude towards freer trade. Though New Delhi has pushed ahead with bilateral agreements and favours an ambitious timetable for sealing a Doha deal, it raised protectionist barriers on some imports this year and said core issues in the Doha round remain unresolved. [nSGE60A0F9] What to watch: -- Any sign India -- and the United States -- are more prepared to make concessions to achieve a new trade deal. (Compiled by Andrew Marshall and Krittivas Mukherjee