NEW DELHI: The prospect of an indecisive 2014 election in India is eroding confidence among global investors that the government can stop the rupee’s worst drop in more than two decades.

The $1.8 trillion economy needs “radical reforms” neither Prime Minister Manmohan Singh’s administration nor the next government can undertake, said Lutz Roehmeyer, a fund manager at Landesbank Berlin Investment. Fisch Asset Management Ltd. treats the nation’s bonds as junk because of the “mess” created by politics. Legg Mason Inc. is concerned the nation’s leaders will be hamstrung by compromises needed to stay in power.

“They need to provide confidence to international investors, particularly with an election coming up,” Amanda Stitt, investment director at Legg Mason Global Asset Management, which oversees about $436 billion of debt, said in a telephone interview from London. “The government understands the problems. It’s just whether they have the political ability to deal with them.”

The rupee has slumped 15 per cent this year against the dollar, the most in Asia, and the benchmark bond yield touched a 12-year high this week as the economy expands at the slowest pace in a decade amid twin current-account and budget deficits.

Opinion surveys show the single largest party to emerge from the polls will control the fewest seats on record in parliament, meaning it will need the support of several smaller ones to form a governing coalition.

No party has won an outright majority in India since 1989, requiring coalitions of parties representing different regions and religious castes striking deals with each other to stay in power. The fewer the seats a leading party wins, the more the trade-offs with potential allies.

There are 39 parties in the 545-seat lower house of India’s parliament, and nine in Singh’s ruling alliance. India needs to hold the next election by May.

In the past two decades, the nation’s currency has weakened before four of the five elections on concern instability will hamper policies. In the 12 months before the 2009 ballot, the rupee slid 14 per cent against the dollar, according to data compiled by Bloomberg.

Among the challenges a new government is set to face are politically sensitive measures such as reducing fuel subsidies in a country where the World Bank says two thirds of the 1.2 billion people live on less than $2 a day.

Singh’s attempt to pass bills such as allowing foreign companies to sell insurance and pensions and changes to a law on how land is purchased for industry have been thwarted by coalition partners.

His biggest ally Trinamool Congress quit in September 2012, opposing decisions to raise diesel prices and allow foreign supermarkets. In March, the regional Dravida Munnetra Kazhagam pulled out over India’s policy toward Sri Lanka.

“Most of the mess is created because of politics,” said Philipp Good, who manages $800 million of global bonds, including Indian securities, at Fisch Asset in Zurich. “Political risks are significant. With elections next year, most probably, it will be a coalition, and it’s not positive for reforms.”

India’s prospect for growth in the longer term is bright, said Bill Maldonado, chief investment officer for Asia Pacific at HSBC Global Asset Management, which manages $413 billion.

“Just think about what the potential can be with the right reform agenda and infrastructure,” he said in an interview on Wednesday. “How much of that requires new legislation and a working majority in any government? I think the answer is a lot less than people assume.”

Maldonado said HSBC is concerned about the “long period of uncertainty” before the elections and questioning its positive stance on India.

Asia’s third-largest economy is seeing capital flow out at a time when policy makers are trying to attract funds to offset a current-account deficit, which widened to a record 4.8 per cent of gross domestic product in the year ended March 31.

Global funds have pulled out an unprecedented $10 billion from local-currency bonds since holdings touched a record $38.5 billion in May, after the US Federal Reserve signalled it may start paring its stimulus and corruption allegations against the ruling coalition deepened a gridlock.

Singh’s administration has passed the fewest number of bills ever by a government sitting a five-year term.

In the current monsoon session that started Aug. 5, the lower house has wasted 85 per cent of the time, spending only 12 minutes discussing bills in the first seven sittings, according to PRS Legislative Research, a group that tracks parliament.

“We are now entering a period of extreme turbulence, the volatility in the next 10 months is going to be very high,” said D.H. Pai Panandiker, president of the RPG Foundation, a New Delhi-based economic research group.

“There is not going to be any stability until after we find out the next government.”

The Reserve Bank of India, which has tightened cash in the financial system since mid-July to stem the rupee’s slide, said it will buy 80 billion rupees ($1.2 billion) of long-dated bonds tomorrow after a surge in yields threatened to choke the economy.

“What we need are quick fixes and we can’t wait till next year,” said Roehmeyer, who helps manage the equivalent of $15 billion in assets, including corporate bonds, at Landesbank in Berlin. “I don’t have much hope. I think people are too complacent and corruption is a big issue.”

Legg Mason’s Stitt favours Indian corporate debt over its sovereign securities as the government struggles to attract foreign investment to cover a deficit and stabilize the rupee.

Neither of India’s main alliances would win more than 30 per cent of seats in parliament if voting were to be held now, according to an opinion poll released by Times Now television channel and C-Voter polling agency at the end of last month. No margin of error was given.

“No one can predict which government will emerge,” said Satish Misra, a political analyst at the Observer Research Foundation, who has covered the country’s politics for more than three decades. “Indian politics is in a state of flux.”

By arrangement with the Washington Post/Bloomberg News Service