The belligerent provocation of various Indian minorities has raised ethnic tensions, says Moody's Analytics in a report that warned of "a possible increase in violence".
In a report titled 'India Outlook: Searching for Potential', Moody's Analytics, a division of Moody's Corporation, said: "Along with a possible increase in violence, the government will face stiffer opposition in the upper house as debate turns away from economic policy."
Moody's Analytics, a top economic policy research and analysis institution, said the politics need to improve and the government's reform agenda needs attention to achieve long-term growth.
While the government met with obstructionist opposition in the upper house with regard to crucial reform measures, the ruling party also hasn't helped itself with controversial comments by its members, Moody's Analytics said.
The Indian economy is likely to grow at 7.6 percent this year and in 2016 while closing of negative output growth is going to be difficult due to external headwinds and the government failing to deliver on reforms, it added.
"Overall, it's unclear whether India can deliver the promised reforms and hit its growth potential. Undoubtedly, numerous political outcomes will dictate the extent of success."
According to the report, the Indian economy is expected to grow around 7.3 percent year-on-year in September quarter which is below the expected potential of around nine or 10 percent.
Expecting the gross domestic product (GDP) to grow at 7.6 percent this year and 2016, Moody's Analytics said key economic reforms like goods and service tax, revamped labour laws and land acquisition bill would improve India's productivity.
According to the report, low interest rates will help the economy in the short term and the financial market sentiment has faded. Further rate cuts in 2015 are unlikely, but there is room for more next year.
The Indian stock market and the foreign inflows are down while the strong external headwinds-slowdown in global growth are hurting Indian exporters.
Moody's Analytics expects Indian exports continue to fall in 2016 while the newfound stability in India's current account balance could come under renewed stress if global growth slows more.
"So far, lower oil prices have buttressed the trade balance. But a rebound in prices if oil supply re-balances could see the trade balance deteriorate," the report adds.
According to Moody's Analytics, indications are there on foreign investors turning less optimistic about India's economic prospects.
"Net financial flows into equity were around $16 billion in 2014. However, they are unlikely to reach those highs this year. The same can be said about financial flows into India's debt market," the report said.
A move towards full capital account liberalisation is inevitable in India and this may happen in the next two to four years.
"A freer capital account will give Indian companies greater access to overseas markets, lower borrowing costs, and facilitate credit growth - a key ingredient to increasing investment," Moody's Analytics said.
