As 'The Indian Queen' opens, can Peter Sellars save the ENO?

These are grim times at English National Opera. Earlier this month the company, which occupies the London Coliseum, the capital's largest theatre, was placed in "special measures" by Arts Council England: it has two years to shape up or face the funding axe. Its chairman, Martyn Rose, and executive director, Henriette Götz, had resigned within two weeks of each other, while the artistic director, John Berry, holds on despite a barrage of criticism; vision, finance and politics both internal and external seem much at odds.

Non-artistic money-saving measures are underway. For instance, some of the offices are being moved from St Martin's Lane to the company's run-down West Hampstead rehearsal studios. In the theatre foyer, even at the most successful performances, the atmosphere feels muted and tense. The staff keep smiling, but it's hard not to detect an underlying air of despair.

Inside the studio, though, the inspirational Peter Sellars, ENO's director-in-residence this season, is bringing a ray of Californian sunlight into the glumness as he rehearses his next production: Purcell's unfinished swansong, The Indian Queen. Sellars, 57, doesn't yell at his cast. He hugs them. He hugs everyone.

Hugs often feature on his stages, too, notably in his visualisation of the Bach St Matthew Passion, as seen at last year's Proms. But equally ubiquitous is the social conscience that informs his productions. This one is no exception: among its painted panels in brown, green, teal and amber by the California street artist Gronk, is the shape of a tank steaming into the rainforest.

Sellars, with his trademark on-end hair and impish warmth, has constructive words for the troubled company. "In general, I think ENO's boldness is very exciting," he says. "In the six months I've been here, their consistent artistic excellence has been astonishing. Their performances night after night are absolutely engaging and perfectly serious, and the range of what they're doing is impressive. The lack of orthodoxy is a joy."

He points, too, to the value of ENO's collaborations with smaller spaces such as the Young Vic and the Barbican, where a forthcoming new opera by Tansy Davies, Between Worlds, will be seen. "Opera needs to diversify in scale again," Sellars says. "It wasn't always this elephant. It was quite light on its feet for a lot of its history and I think we need to be in that mode again. Sometimes we want to gather resources to put on a Parsifal, but I think just performing for the real estate is a mistake. You're not going to sell out the Coliseum the way you could a generation ago, partly for economic reasons.

"But also, the next generation is looking to buy their vegetables at a farmers' market, not a supermarket," he continues. "They want that taste, that crunch, that flavour. I think they're looking for more intimate musical experiences where you're close enough to taste the quality of the work. Opera can operate on many different levels, for many different metabolisms and on many different social scales and that diversity is a very good thing."

The Indian Queen, a co-production with the Perm State Opera, Russia, and the Teatro Real, Madrid, comes to ENO hot on the heels of Sellars' world premiere staging of John Adams's The Gospel According to the Other Mary. He is the operatic right-hand man to Adams and has collaborated closely with him for several decades: "It's a bit like a marriage," he says of their working relationship, "full-on, with its moments of pure exhilaration, quiet repose or agitation when everybody has to take a deep breath and try again. But it's the most exhilarating fact of my life. My mission is just to make sure that John Adams has material to inspire that music."

This partnership, he says, has helped him to feel freer when tackling a rethink of Purcell. "Composers are not the bust from the conservatory," he points out. "This was a person with whom you'd be working in that same way. The sense that Purcell is here to be engaged with, rather than admired, becomes normal."

Sellars is now bringing to Purcell his individual brand of dramaturgy. Generally his work draws on eclectic influences, from French experimental theatre to Japanese kabuki and African ritual. The effect can be stylised, stunning, spiritually charged and often all three at once, recognisable as his within moments. This one, with a starry cast including the American tenor Noah Stewart and the English soprano Lucy Crowe, is no exception.

The Indian Queen's score was left unfinished on Purcell's death, aged 36; its original play by John Dryden is, according to Sellars, "unrevivable". He has replaced it with a spoken text drawing on the Nicaraguan novelist Rosario Aguilar's The Lost Chronicles of Terra Firma, telling of the Spanish invasion of the Mayan people from the women's point of view; and to bridge musical gaps he has incorporated music from Purcell's religious anthems and theatrical songs.

This reconstructive approach could make the fur fly among purists in the composer's native UK, but Sellars is not worried. "I think people will be overwhelmed," he declares. "We're valuing Purcell more deeply, opening a space where his achievements can speak with all the intensity he put on the page. Today we don't have to allow the music to be held ideologically captive. We're past the ideological battlefield of baroque music and now people are finding that music of every period has many possibilities. This is the 21st century and we are letting a hundred thousand flowers bloom."

Some people still insist that the arts should somehow be above politics, but Sellars profoundly disagrees. "Look at every note Mozart and Beethoven wrote," he protests. "Check out Monteverdi. Examine Mussorgsky, Schoenberg, Stravinsky. The amount of opera that isn't political is a tiny percentage."

"This is a period of mass intimidation, one where it's no accident that governments are not only cutting the arts but destroying education," he says. "They want a frightened, docile population that's easily manipulated – and the arts are about thinking for yourself. The arts are about independent-mindedness, about checking out multiple points of view; that's built into the DNA of the arts, which is why the arts are very annoying in a period of proto-fascist economic regimes. And the middle class has been specifically targeted and decimated, so now people can't subscribe to a whole season of concerts or operas; they might have to choose just one to attend.

"All over the world," he continues, "you can't sell out a season any more, in the concert hall, opera house or theatre, because the discretionary money that the middle class used to have has been eliminated and middle-class people are struggling. I think it's a very specific situation that only has to make us bolder – because, guess what, our survival is at stake. So the arts need to stand for something, at a time when we all need to stand for something; and the arts should be in the lead, not in the back.

"We're no longer in a mode where we must sing for our supper," he says, "so we can at least do what artists do in difficult times, which is to speak out with candour, courage and authority. That's our job." If anyone is ready to lead the charge, it is he. ENO is lucky to have him on location.

'The Indian Queen', ENO, London Coliseum (020 7845 9300) to 14 March