by David J. Karl and Samir Kumar
India’s parliamentary elections began yesterday, with the results scheduled to be announced on May 16. By all accounts – see here and here for example – Narendra Modi, the business-friendly chief minister of the northwestern state of Gujarat, will be elevated to the prime ministership and his Bharatiya Janata Party (BJP) will emerge with the lion’s share of the vote. Indian corporate leaders are pinning their hopes on Modi being able to revive the faltering economy and rejuvenate what many now see as rudderless policymaking in New Delhi. This prospect has sent the country’s stock markets booming (here and here) and led Goldman Sachs to raise its investment stance on India.
Under Modi’s leadership, Gujarat over the past dozen years has become a major industrial hub. In the 2005-2012 period, the state experienced an average annual growth rate of over 10 percent – the second highest-pace among the larger Indian states. One Washington-based think tank ranks Gujarat as the most economically-free state in the country. The Economist magazine recently termed the state “India’s Guangdong” and said it “offers a glimpse of a possible industrial future for India.” McKinsey is similarly laudatory, and some are even speaking of Modi as a new Thatcher.
In a series of addresses over the past two months, Modi outlined the economic agenda he intends to pursue in New Delhi, which has now been formalized in the election manifesto that the BJP has just released. Speaking at a party leadership conclave in January, Modi laid out an ambitious plan for infrastructure development, including modernization of India’s decrepit energy and transportation systems. In particular, he spoke of building high-speed rail networks and upgrading river transportation. He also promised to spur urbanization by building 100 new technologically-advanced cities and expanding existing metropolitan centers in smarter ways.
Modi added to this agenda a month later in appearances before business conferences in New Delhi (here and here). Reversing his previous stance, he came out in support of a nationwide goods and services tax (GST), India’s version of the value-added tax that would replace the fragmented system of indirect taxes the central government and the states currently levy at different stages of the supply chain. He also hinted that the BJP would rethink its current opposition to greater levels of foreign investment in the e-commerce and multi-brand retail sectors.
Modi first made his mark in Gujarat by reforming the state’s broken electricity sector. As result, the state is one of the few power-surplus states in the country and the promise of reliable electricity is a major factor for why Gujarat has become a magnet for foreign investment. Ahmedabad, the largest city in Gujarat, is also noticeably less gridlocked than other major urban areas. A keen focus on infrastructure development would be a hallmark of a Modi-led government in New Delhi. If he ends up in the prime minister’s office, expect a quick campaign to revive dozens of infrastructure projects that have been entangled, in some cases for years, in bureaucratic red tape. In India’s federal system, state governments play a major role in projects, especially in land acquisition and environmental clearances. Still, the signals Modi would send to BJP-run state administrations about project execution will have an important effect. And increased infrastructure spending and greater regulatory efficiency by the central government should reawaken the interest of U.S. infrastructure developers and investors that have long shied away from India. Already, infrastructure firms in other countries (here and here) are looking anew at India.
Modi’s efforts on this front could generate profound economic dividends. According to the new Global Competitiveness Report put out by the World Economic Fund, the ramshackle condition of Indian infrastructure is the most problematic factor for doing business in the country. In terms of the quality of overall infrastructure, the report ranks India 85th out of 148 countries – for reference, China is ranked 48th. In its latest State of the World’s Cities report, the United Nations scores infrastructure in New Delhi and Mumbai far below other Asian cities like Beijing and Bangkok. Due to the inadequacies of the rail system, the PricewaterhouseCoopers consulting firm estimates that two-thirds of the country’s freight is moved by ground transportation, further clogging the ill-maintained road system. And a just-released study by the International Monetary Fund finds that a slump in infrastructure development is an important contributor to India’s current growth slowdown.
Ditto for the urbanization process. Goldman Sachs reckons in a new report that the urbanization rate in India was about 20 percent in 1980, a figure higher than that of China at the time. Since then, however, China’s rate has zoomed to over 50 percent, while India’s has only moved to just over 30 percent. The investment bank calculates that urbanization contributes 2-3 percentage points to GDP growth in China and believes that accelerated urbanization would add some 1.8 percentage points to Indian growth. Indeed, Foreign Policy magazine estimates that the top 35 metropolitan areas in China contributed just under half of its economic activity in 2013.
Given the general political consensus in favor of the GST, Modi as prime minister is likely to move quickly to enact it. The measure would help to create a more unified market in India, increase productivity and enable higher GDP growth. A study a while back by the National Council for Applied Economic Research in New Delhi estimated that a comprehensive GST would increase GDP by 0.9 to 1.7 percentage points. And UBS bank believes that “The introduction of the GST is a key reform measure that could have immense macro implications for India’s growth potential.”
On a related front, the election manifesto criticized what it called the incumbent government’s “tax terrorism” and instead promised more investor-friendly tax policies. Prolonged disputes between the tax authorities and such foreign companies as Vodafone, Nokia, Shell and IBM have put major dents in the country’s reputation as an investment destination. A new survey by the Deloitte consulting firm finds that India’s tax regime is among the most complex in Asia and that is a key concern for investors.
Disappointedly, however, the election manifesto promises to roll-back current national policy granting the individual states authority to decide whether to permit foreign participation in the multi-brand retail sector in their areas. This policy stance, tepid as it is, has attracted considerable political opposition, especially from the BJP. In recent months, newly-elected governments in Rajasthan state and the municipality of New Delhi have overturned the previous administrations’ decision allowing foreign retailers like Walmart and Tesco to set up supermarket chains. Last fall, the resistance caused Walmart to shelve long-standing plans to expand into the Indian retail sector.
It is discouraging that the BJP is moving backwards since retail-sector liberalization would have major positive ramification. A recent study by the Boston Consulting Group and the Confederation of Indian Industry concludes that it would create 3-4 million jobs directly and another 4-6 million through its indirect effects. It would also save consumers $25-30 billion a year and increase government tax revenues by a similar amount. Just as important, retail liberalization would go far in rectifying the country’s grossly inefficient and corruption-riddled food procurement, storage and distribution system. This, in turn, would give solace to consumers, especially the poor, who have for years been plagued by the world’s worst food inflation.
Frustrating, too, is that the BJP’s announcement undercuts what has been a salutary development over the past decade or so: The emergence of the states as laboratories for policy experimentation. Indeed, no place better exemplifies this trend than Gujarat under Narendra Modi. For example, many experts believe that the anarchic laws governing labor markets have stifled the growth of labor-intensive manufacturing, something which should be a huge comparative advantage for India. Under Modi, Gujarat has instituted a more flexible interpretation of these laws. The Goldman Sachs report estimates that if the rest of India did the same, the result would be the creation of some 40 million new manufacturing jobs over the next decade and that an even more basic reform of labor regulations would lead to 110 million jobs during that period. Modi has spoken about devolving labor laws to individual states and according to some media reports the BJP is even contemplating labor reforms. But in light of its just-announced policy on retail liberalization as well as the high political costs such a step would entail, one must remain skeptical of these reports.
These disappointments aside, the overall agenda Modi and his colleagues have sketched out represents good news for most foreign companies looking to the Indian market. But how likely is it that Modi will be able to deliver? He has loads of experience successfully governing a medium-sized state where the BJP has long held legislative control and he has wielded unchallenged political authority. The party is likely to post impressive gains in the parliamentary elections but they likely won’t be enough to allow Modi to put together a national government without the support of other political groups. Given the growing fragmentation of the Indian political system, no government in New Delhi has formed without coalition partners in a quarter of a century. The need to bring on coalition partners that do not share all of his economic views will necessarily constrain Modi’s freedom of action. Indeed, one analyst warns that India is “in for a period of political instability with a fractious coalition regime that is unable to forge a viable working consensus.”
Moreover, Modi has little experience operating in New Delhi’s political milieu, where unlike in Gujarat he will need to coax, wheedle, persuade and entice other leaders in order to accomplish things. Over the years, he has kept his distance from the national capital and purposefully runs his electoral campaign from his home state. Unlike almost all of the others elected to the prime ministership, he made his name at the state level. No doubt, this background adds to his popular appeal as an outsider intent on shaking things up. But it also means that the hard-charging persona he employed to great effect in Gujarat – bulldozing through the bureaucracy and the political opposition – is unlikely to translate well if he ascends to the national stage. It remains to be seen whether he is capable of making the necessary adjustments in his governance style.
These political factors mean that a Modi-led government will not live up to much of the hype now being peddled about his candidacy. Nonetheless, as earlier Intel Blog posts (here and here) note, the economy for all of its current malaise retains some enduring strengths. (Also see this new CNBC report on the point.) At present, the latent dynamism is being shackled by policy lethargy in New Delhi. But Modi should be able to inject enough vigor and decisiveness into policymaking to restore at least some of the economic mojo that commanded the world’s attention just a few years ago.