* Parties unveil populist measures
* Investors not surprised, but watchful
* Free water, subsidised gas dished out
NEW DELHI, Feb 3 (Reuters) - India's political parties are unveiling populist measures in a competition to win over voters before a national election due in two months, even though the domestic economy is struggling to recover from the worst slowdown in a decade.
In the past two months, the Indian electorate has been showered with goodies such as free water, cheaper electricity and subsidised cooking gas. Some political leaders are also promising free health care, minimum guaranteed farm wages and even the abolition of income tax.
All these measures are being taken or promised at a time when public finances are in dire straits and investors are looking for a signal from politicians that they are ready to take hard decisions to generate an economic rebound.
"Obviously, these things don't excite investors. But they have all priced it in their investment decisions," said Rahul Bajoria, regional economist with Barclays Capital in Singapore. "If it becomes a national trend, it will be a concern."
No date has been set for the election but it must be held by May. Investors are hoping it will result in a government strong enough to take hard decisions to revive an economy that is growing at about its slowest pace in a decade.
Rating agency Standard & Poor's has threatened to strip India of its investment grade credit rating if the election fails to provide a government capable of taking growth-friendly decisions.
The main opposition Bharatiya Janata Party (BJP) has a good lead in opinion polls over the ruling Congress-led coalition, which has governed for 10 years. Once the date is announced, the government is barred from announcing new policies, hence the rush.
GOOD ECONOMICS, BAD POLITICS
India's political class often views good economics as bad politics. That view came into question after Congress' welfare measures failed to find favour with voters in recent state elections, earning a big cheer from investors.
But as recent developments suggest, political parties are still wary of bold economic reforms.
That was why the new Aam Aadmi, or Common Man, Party (AAP) government in the national capital wasted no time in acting upon its promise of free water and cheaper electricity, drawing demands by lawmakers in other states for similar reductions.
With the AAP's populist measures threatening to eat into support for Congress among the poor, the ruling party joined the bandwagon to protect its core voters by cutting electricity tariffs by a fifth in the western state of Maharashtra.
Last week, it increased the subsidy on cooking gas, which would cost the federal exchequer about $800 million. Under this popular scheme, households are entitled to buy the gas at less than half the market price.
On Monday, the government cut the prices of natural gas used for transport and domestic purposes.
Spending on subsidies such as food, fuel and fertiliser, which amounted to nearly 2.5 percent of India's gross domestic product (GDP) last year, is not only the bane of government finances, but also a major concern for investors.
While Congress is known for its penchant for populist welfare schemes, the BJP has also failed to enhance its image as a reform-oriented party.
BJP's prime ministerial candidate Narendra Modi is leading in opinion polls and is widely expected to replicate his success in pushing tough reforms in the western state of Gujarat.
But in a setback to investor confidence, his party's government in the northern state of Rajasthan has barred foreign direct investment in supermarkets, overturning the policy of the previous, Congress-led administration.
In a bid to win over crucial middle-class and urban voters, some BJP leaders are also promising to scrap income tax, which is the government's most reliable revenue stream.
The party is also considering expanding India's welfare programmes by promising a "right to health".
"In the lead-up to elections, you are likely to see such things," said Sanjay Sinha, a veteran fund manager who founded Citrus Advisors, an investment advisory firm. "This apprehension has made markets a little weak in the lead-up to elections." (Editing by Angus MacSwan and Gareth Jones)