By Matthias Williams and Satarupa Bhattacharjya
NEW DELHI, March 15 (Reuters) - The Indian government was plunged into yet another crisis on Thursday by a rebellion within its own ranks over a proposed rise in rail fares, underscoring its inability to take unpopular steps and frailty in the face of querulous coalition allies.
The latest pressure on the government has fanned speculation that it could fall, triggering an election two years ahead of schedule. However, analysts said most political parties had no appetite for an early poll and -- although a mid-term vote cannot be ruled out -- the government was likely to limp on.
Breaking with years of populist policies, Railway Minister Dinesh Trivedi this week announced the first increase in passenger fares in eight years, a move aimed at shoring up the finances of a rail network whose dysfunction has become a major drag on the economy.
The move cheered investors but prompted a furious response from Trivedi's own party, a powerful regional group within the ruling coalition that has impeded economic reform in the past.
Amid chaotic scenes in parliament, reports flew that the railway minister had been forced by his party's firebrand leader, Mamata Banerjee, to resign. The crisis quickly cooled, however, as it emerged that he had not offered to go.
Speculation has mounted in the media that Trivedi's Trinamool Congress party may turn against Prime Minister Manmohan Singh's coalition, potentially bringing the government down and triggering an election two years ahead of schedule.
"Here is a government literally lurching from one crisis to the next one, and here is a government that seems to be barely able to govern," said political analyst Paranjoy Guha Thakurta.
Even if the government does cling on, the brinkmanship of unreliable allies is likely to continue, keeping Singh on the backfoot and limiting his room to push through reforms that could lift economic growth from its lowest rate in nearly three years.
"He (Singh) is weaker than he was even a year go," said D.H. Pai Panandiker, head of the RPG Foundation, a Delhi-based think tank. "Any major policy reform will now be very difficult."
Few expect the allies to push Singh over the edge, and even if Trinamool Congress did pull out of his United Progressive Alliance (UPA), he could turn to other regional parties to maintain the parliamentary majority he needs to stay in power.
Nevertheless, the muscle-flexing of an important partner in the government reduces the chances that Singh will be able to cut state spending and deliver the fiscal consolidation needed for the central bank to start reducing interest rates.
The Reserve Bank of India kept rates on hold on Thursday and, dousing hopes that it might ease policy soon, said that "fiscal slippage" was contributing to the risks of a resurgence in inflation.
Investors will be watching the announcement of the 2012/13 budget on Friday for a signal of the government's commitment to reining in a budget deficit swollen by subsidies for the poor.
"None of this augurs well for the upcoming general budget," the Times of India said in an editorial on the rail fare row.
"There'll be misgivings about (Trinamool leader) Mamata playing to the gallery by bashing any reform the finance minister proposes in the budget. So, he might think it better to play safe than sorry."
The government has been battered over the past 18 months by a string of corruption scandals and 79-year-old Singh, architect of economic reforms 20 years ago that delivered India's economic boom, has been unable to take significant policy steps.
Last year, Trinamool Congress thwarted a plan to allow foreign retailers such as Wal-Mart Stores Inc to enter the country's supermarket sector, tarnishing India's reputation among investors.
That was just one of several policy flip-flops, the most recent of which came over a ban on cotton exports, and fumbles such as its botched auction of a 5 percent stake in state-run Oil and Natural Gas Corp earlier this month.
The government was further weakened last week when Singh's Congress party was trounced in a state election despite the energetic campaigning of Rahul Gandhi, scion of the Nehru-Gandhi dynasty that has dominated politics in the world's biggest democracy after its independence from Britain in 1947. (Writing by John Chalmers; Editing by Sanjeev Miglani)