India is a vibrant parliamentary democracy and has been one since its political independence from British rule more than 50 years ago. There is no serious revolutionary movement in India; hence there is no conceivable possibility of the state collapsing. Sovereign Risk in India is therefore zero for both "foreign direct investment" and "foreign portfolio investment." It is however advisable to avoid investing in the extreme north-eastern parts of India because of terrorist threats. Kashmir in the northern tip is also a troubled area, but investment opportunities in Kashmir are anyway restricted by law.
India suffered political instability for a few years due to the failure of any party to win an absolute majority in Parliament. However, political stability has returned since the previous general elections in 1999. However, political instability did not change India's economic course though it delayed certain decisions relating to the economy.
The political divide in India is not one of policy, but essentially of personalities. Economic liberalization (which is what foreign investors are interested in) has been accepted as a necessity by all parties including the Communist Party of India (Marxist).
Thus, political instability in India, in practical terms, posed no risk to foreign direct investors because no policy framed by a past government has been reversed by any successive government so far. You can find a comparison in Italy which has had some 45 governments in 50 years, yet overall economic policy remains unchanged. Even if political instability is to return in the future, chances of a reversal in economic policy are next to nil.
As for terrorism, no terrorist outfit is strong enough to disturb the state. Except for Kashmir in the north and parts of the north-east, terrorist activity is either non-existent or too weak to be of any significance. It would take an extreme stretching of the imagination to visualize a Bangladesh-type state-disrupting revolution in India or a Kuwait-type annexation of India by a foreign power. Hence, political risk in India is practically non-existent.
Commercial risk exists in business in any country. Not each and every product or service can be readily sold, hence it is necessary to study the demand/supply situation for a particular product or service before making any major investment. There is a large number of market research firms in India (including our own) which will study demand/supply situation for any product/service and advise the potential investor accordingly in exchange of a professional fee.
Risk of Foreign Sanctions
India did not seem to be in the good books of the United States government due to its nuclear weapons and missiles development policy. However, US President Bill Clinton's state visit to India in 2000 was a massive hit which even saw the President dancing with a crowd of colorfully dressed women in the northwestern state of Rajasthan. Subsequent to the visit, visits between the two countries at different levels took place, and the US government has all but come to terms with the reality of a nuclear-armed India.
Background to the sanctions: The US had imposed some sanctions against India because of its nuclear tests in May 1998. But these sanctions have been theoretical and even such theoretical sanctions were relaxed within months of their imposition. Given the fact that US foreign policy in the post-Cold War era is dictated by its economic interests, it anyway seemed most unlikely that Iraq or Libya-type sanctions would ever be imposed on India. India is highly self-sufficient in terms of basic technology and requirements; hence the threat sanctions could not bring India to its knees. The United States seems to understand this which is perhaps why it never went ahead with really biting sanctions against India.
Regardless of how strong the threat of sanctions were, the US President's above-mentioned state visit to India has laid to rest all doubts. In fact, the United States has often referred to India as a great potential trading partner as well as, perhaps, a politically strategic partner in Asia. India's rapidly improving relations with Israel has only lent further momentum to India-US bonding.
Given the fact that the United States has somehow managed for itself the role of the world's policeman (a role to which India is explicitly opposed), other countries – notably Japan and Australia – have also toned down their opposition to India's nuclear weapons programme. In other words, it is now business as usual for the world vis-à-vis India.
It is however theoretically possible those relations with the United States can go sour again in the future. If that happens, India's sheer self-sufficiency in all matters except in the not-so-critical cutting edge technologies will ensure that no sanction will hurt more than a mosquito bite on an elephant.
The threat of foreign sanctions is therefore of academic and speculative value. Source: India One Stop