An abiding memory from backpacking around India 20 years ago was local villagers leaving their laundry between the rail tracks to dry, as trains with hole in the floor toilets trundled over, in what might be called Indian roulette, a triumph of hope over realism which policy makers have been playing with the economy, with predictably unpleasant results. It can only be hoped that the 5.3% y/y quarterly growth rate in Jan-Mar, the lowest in nine years, will finally concentrate political minds. Independent consensus growth forecasts have fallen to 6% for this FY; the rupee continues to slide perilously toward 60 to the USD, offsetting the inflation windfall of lower global energy prices.

Those sectors combined make up roughly 26% of GDP including domestic retail and wholesale trade, and grew just 7% during the quarter, down from 11.6% during the same period a year earlier, while manufacturing output fell by 0.3%, from growth of 7.3% the prior year (and the March number at -3.5% suggests a very weak start to this FY). With the current account deficit at 4% of GDP, a fiscal deficit approaching 6%, a trade deficit of almost 10%, and inflation still above 7% things could get very ugly if urgent remedial action isn’t taken this summer. The rupee’s volatility has risen to almost 14%, while 6mth non-deliverable forwards price the rupee above 58, putting the RBI’s credibility on the line. It’s hard to see a near-term improvement in the twin deficits, weak FDI and FII capital flows, or India’s higher sovereign risk premium, and India has become in many ways Asia’s equivalent of a peripheral euro zone economy, complete with dysfunctional government.

Investors welcomed its decision last week to allow state-controlled oil companies to increase petrol prices for the first time in six months, enabling them to recover some of their losses due to higher oil prices and a plunging currency. But the 6.28 rupees per litre (or roughly 11%) increase sparked public protests and some of the Congress party’s coalition partners have distanced themselves from the decision. The backlash over the petrol price increase has already prompted the government to drop any immediate plans to raise the price of heavily subsidized diesel and kerosene, a move investors have been pushing for to narrow the fiscal deficit. Congress’s second-largest ally in parliament, the DMK party, even threatened to quit the government this week. India clearly can’t wait until 2014 for a renewed burst of reformist energy, and the confusion between Congress leader Sonja Gandhi and PM Singh over who really wields power still has to be resolved.

The only sustainable solution is structural reform and tighter fiscal policy, but issuing dollar sovereign bonds is one option to buy some time, despite a government preference for having most of its liabilities rupee-denominated rather than hard currency. There are reports that the central bank is considering selling dollars directly to oil importers, but that could strain the RBI’s FX reserves, which at $250bn are only 40% larger than the 2011/12 trade deficit.. Another option is to raise the cap on foreign institutional investment in government and corporate bonds – each of which the government raised by $5bn, to $20bn and $15bn, respectively, last November. The best option to bring dollars into the country is probably the issuance of dollar-denominated bonds to non-resident Indians, similar to fixed deposits in which the FX burden is on the government, a move which could raise $10-15bn. If a sustained fall in oil prices brings the current account deficit down toward $60bn from a current $70bn estimate in this FY, this additional and pretty ‘sticky’ funding source could help improve more volatile FII sentiment and flows. Chronic and worsening stagflation will be a lot more politically painful for Congress than facing down subsidy protests or its coalition partners, which may finally energise policy.