* Probe will allow parliament to debate Feb. 28 budget
* Investors increasingly wary about impact of scandals
* Pressure on Singh, doubts remain on reform appetite
(Adds details, reaction)
By Alistair Scrutton
NEW DELHI, Feb 22 (Reuters) - Indian Prime Minister Manmohan Singh gave in on Tuesday to opposition demands for a parliamentary probe into a multi-billion dollar scandal over sales of telecoms licenses for kickbacks, a setback for his embattled government and a victory for the opposition.
Singh, wary that a parliamentary probe could drag on for months and overshadow his Congress party-led coalition, only bowed to pressure after months of opposition protests stalled the last parliamentary session and threatened to block passage of the Feb. 28 budget.
"Our country can ill afford a situation when parliament is paralysed," Singh told parliament.
The Hindu newspaper on Tuesday called the scandal, in which the state auditor said up to $39 billion was lost in revenues, "the biggest scam in the history of independent India."
The government will likely stay in power, but is wary of a repeat of 1989 when Congress lost a general election due to the Bofors scandal over gun contracts involving associates of then Prime Minister Rajiv Gandhi who were accused of taking bribes.
The latest controversy has halted the progress of reform bills and worried some investors in Asia's third biggest economy. Concerns about security of contract, combined with the global slowdown, have hit foreign direct investment and contributed to the Mumbai stock exchange's recent performance, the worst of the world's major share markets.
Parliament may now be open, but investors doubt their wish list of modernising laws will be passed. Even before the latest scandal, the prime minister was on go-slow with reforms seen as helping India compete with the likes of China.
Singh, accused by the opposition of allowing corruption to go unheeded during his seven year rule, even within his cabinet, now faces two battle fronts -- the parliamentary probe and an ongoing police investigation.
The federal police have arrested his former telecoms minister and questioned some of India's most powerful businessmen, including billionaire telecoms tycoon Anil Ambani, owner of No. 2 mobile carrier Reliance Communications .
Pushed on by a newly assertive Supreme Court, the police have until Mar. 31 to issue charge sheets.
What is unclear is whether this probe will end in catharsis for a globalising India that shows itself capable of rooting out corruption, or whether it will end in bitter acrimony and mudslinging with little progress in the probe.
While corruption has been endemic in India for years -- one study said it shaved one to two percent off India's growth rate -- there are signs that an assertive judiciary, an aggressive media and a growing middle class are increasingly intolerant of graft.
The scandals have piled enormous pressure on the reformist 78-uear-old prime minister, seen as a lame duck who plays second fiddle to Congress party head Sonia Gandhi. Some believe further revelations could force him from power early and lead to an interim leader before a 2014 general election.
There are also increased rumblings of dissatisfaction within some Congress circles over his performance in the second term, and calls for the government to focus on leftist policies.
The telecoms probe will be a boon for the opposition, headed by the Hindu nationalist Bharatiya Janata Party (BJP) which is regaining momentum after its 2009 general election loss to a coalition headed by the Congress party.
It is unclear how long the parliamentary probe will last but it could dominate parties' agendas ahead of state elections in Tamil Nadu and West Bengal states this year -- votes that could set the stage for coalition building ahead of the 2014 general election.
The last joint parliamentary probe (JPC), set up in 2003 to look into reports of pesticide residues in soft drinks, lasted six months. The longest probe was into stock marked manipulation in 1992-1993, and it lasted 16 months.
"Nobody is pointing fingers at his (Singh) involvement. But so far as his ability to control and steer the ship of state is concerned, that is under question," said Sudheendra Kulkarni, a political analyst and a former BJP adviser.
"What could affect the stability of the government is if the JPC itself comes out with something incriminating."
The Sensex index of Indian stocks is down around 11 percent this year, and foreign direct investment is down 27 percent this year.
Reforms to allow foreign investment in the financial sectors have been languishing in committee for years, while polices to open up the modern supermarket sector face opposition from within the Congress party, worried about the impact on farmers and small stores across rural India.
A goods and services tax, seen as cutting business costs and boosting government revenue, may be introduced but it will be debated in this session. Plans to introduce the tax have been delayed until April 2012. States controlled by the BJP have raised concerns about the reform, potentially killing it off.
A bill to make it easier to acquire land to set up factories, mines, roads and power plants, may be introduced but is not listed for debate. The bill is seen as resolving one of the biggest barriers for sustained double-digit economic growth.
(Additional reporting by C.J. Kuncheria; Editing by Paul de Bendern and Daniel Magnowski)