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NEW DELHI (Reuters) - After months of dithering on the economy, India's beleaguered government roared back to life in dramatic fashion on Friday, announcing big bang reforms as part of package of measures aimed at reviving growth and staving off a ratings downgrade.
A day after sharply increasing the price of heavily subsidized diesel, the government said it was opening up its supermarket sector to foreign chains and would allow more foreign investment in airlines and broadcasters. It also approved the sale of stakes in four state-run industries.
Facing the threat of having its credit rating downgraded to junk, the Indian government has been running out of time to show it is serious about fixing an economy that has been hard-hit by a global economic crisis and political gridlock at home.
Underscoring the need for speed, India's inflation rate jumped to 7.55 percent in August, mainly from higher food prices, data showed on Friday.
"I believe that these steps will help strengthen our growth process and generate employment in these difficult times," Prime Minister Manmohan Singh said via Twitter.
Infighting in the fragile coalition government led by Singh's Congress party had earlier forced it to shelve the retail and aviation reforms, casting a shadow over India's aspirations to join the world's leading economies.
Signaling that trouble still lies ahead, two major allies - the Samajwadi Party and the Trinamool Congress party - demanded a reversal of the retail reform and diesel price hike. The government has backed down when faced with such pressure in the past.
The retail reform allows global firms such as Wal-Mart Stores (WMT.N) to hold a majority stake in a local partner and sell directly to consumers for the first time, which supporters say could transform India's $450 billion retail market and tame inflation.
In less than 24 hours, the government announced more measures to liberalize the economy than in the past eight years - a sign of the urgency felt in New Delhi after high spending and low growth battered India's finances in recent months.
"These measures were pending for a long time and the government has now shown political courage to push things through," said Samiran Chakraborty, regional economist at Standard Chartered Bank in Mumbai.
"This should buy some time and rating agencies may wait for the final fiscal deficit number before deciding on India's rating," he said.
But Singh will now need resolve and the support of powerful Congress party boss Sonia Gandhi if he is to muster the political will to withstand popular anger and pressure from coalition allies who fear the reforms will cost them votes.
Street protests organized by opposition parties on Friday against the diesel price increase, where effigies of Singh were burnt, may be a taste of things to come.
The government's main coalition partner, firebrand populist Mamata Banerjee, gave the government a 72-hour deadline to bin the retail policy, but did not say if she would pull out of the alliance if it ignored the ultimatum.
The measures are partly aimed at convincing the central bank to lower interest rates to help revitalize the economy.
While economists do not expect the bank to reduce the cost of borrowing when it meets on Monday - with the higher-than-expected inflation reading seen as putting paid to any chance of a rate-cut - they believe it is now more likely to do so this year.
Singh is due to chair a meeting of government economists on Saturday that could decide to implement budget cuts, a further move to meet the bank's concerns about the fiscal deficit.
Singh's inability to convince allies and his own party to support reforms to ease a high subsidy burden as growth slowed had put India in danger of becoming the first of the big "BRICS" emerging economies to see its credit rating downgraded to junk.
As finance minister in the 1990s, Singh was credited with opening up the economy, but since taking office in 2004 he has repeatedly put off or rolled back difficult economic decisions.
Earlier this year he vowed to revive the economy's "animal spirits", but weeks of inaction followed as his corruption-tainted government was consumed by an outcry over sweetheart deals for coalfields.
The retail reform will allow foreign chains such as Wal-Mart, Carrefour (CARR.PA) and Tesco Plc (TSCO.L) to own a 51 percent stake in supermarkets, opening the door to a market of 1.2 billion people with a rapidly growing middle class. Previously, foreign firms were only allowed to operate as wholesale outlets.
"We are grateful that the government has realized and appreciated the value that we will bring to strengthen the Indian economy," said Raj Jain, president of Wal-Mart India. "This policy change will allow us to connect directly with the consumer and help save them money."
The government has championed the policy as a way to unclog supply bottlenecks that cause a third of fresh produce to rot before it reaches an Indian table. It is hoped global chains will offer better prices to farmers by cutting out middle men, while also pumping investment into cold storage facilities.
But it will also come with stiff riders. Foreign retailers will only be allowed to set up in cities with a population of more than 1 million, and must source at least 30 percent of goods from local, small industries.
State governments will have the freedom to decide whether to allow the supermarkets on their patch and the minimum investment will be $100 million, Commerce Minister Anand Sharma said. Half of that investment must be in rural areas.
The aviation reform will allow foreign carriers to take a stake of up to 49 percent in local airlines, providing a potential lifeline to the country's debt-laden airlines.
Additional Reporting by Satarupa Bhattacharjya, Rajesh Kumar Singh, Annie Banerji, Nidhi Verma, Arup Roychoudhury in NEW DEHLI and Tony Munroe, Nandita Bose and Suvashree Dey Choudhury in MUMBAI; Writing by Frank Jack Daniel; Editing by Alex Richardson and Ross Colvin