AMID the giddy euphoria that greeted the historic victory of the Bharatiya Janata Party (BJP) in India’s May election, hopes have been raised that Prime Minister Narendra Modi and his administration will usher in the start of a new era for the country and bring about an abrupt end to its economic malaise.
The resounding victory has raised hopes of an immediate end to policy paralysis, a kick-start to growth and a general catalytic effect on the economy, which will allow India to roar back as one of the leading emerging economies in the world.
However, it is necessary to interrogate what the victory actually means and, in particular, the what can be expected from the Modi-led administration.
The biggest and most immediate challenge for Modi will now be to lower expectations as to what is realistically possible. Modi, an astute and experienced politician, will be wary of the “Obama effect”, whereby his ability to govern effectively is crippled by the weight of expectation to deliver sweeping reforms promised during an electoral campaign.
The image of a charismatic and decisive leader portrayed on the campaign trail has created a tidal wave of expectation, with the public and investment community already clamouring for a series of “big bang reforms”.
The risk of this positive momentum dissipating is very real unless it is carefully managed. With this in mind, many have been puzzled by the cautious approach so far, particularly the absence of any major policy announcements. However, Modi has quite clearly understood the political calculus, and adopted a very deliberate and pragmatic approach to begin his tenure.
This marks a clear shift from Modi the campaigner to Modi the prime minister, who has understood the magnitude of the challenges ahead of him as well as the confines within which he will operate.
Indeed, since his inauguration, Modi has repeatedly warned of a “bitter pill” to pull the Indian economy out of the rut it is in. The economy requires structural reforms, with priority being placed on bolstering macro fundamentals. These reforms cannot happen overnight, particularly when it comes to politically sensitive issues like labour, energy and agriculture, which require legislative backing.
The Modi administration is therefore wary of eroding too much political capital until it is secure in its ability to execute on such contentious measures. Instead, it has looked to sustain the positive sentiment by offering indications of directional change, rather than anything fundamental.
The complex political dynamics in India and tensions between the centre and state means that the ability to translate lofty election rhetoric into action is constrained. Legislative gridlock is still a major issue, given the fact that the BJP controls only one house of parliament. As a result, it is likely to encounter a number of obstacles to its economic reform agenda – at least in the short term.
Building consensus in the Rajya Sabha, or upper house of parliament, where the party holds only 64 out of 250 seats, will be critical. While Modi may have won the world’s largest democratic election in a decisive fashion, with his party converting 31 percent of the vote into 52 percent of the seats in parliament – he still faces the challenge of a split and hostile legislature.
Congress holds 12 of 29 states, which elect the upper house members; Modi’s BJP has only five. This is especially apparent in the opposition the government faces in passing its Insurance Laws (Amendment) Bill, which proposes to raise the cap on foreign ownership of insurance companies from 26 percent to 49 percent.
Four looming key state elections potentially present an opportunity to consolidate both houses before attempting to push ahead with significant legislative reforms – and have possibly been a key consideration in the conservative political strategy thus far.
Furthermore, many members of cabinet are new to the job and have not yet fully settled into their roles. Being out of power for a decade means that the BJP lacks experienced ministers familiar with the inner workings of national government – evidenced by the fact that Modi’s most trusted minister, Arun Jaitley, is in charge of both defence and finance. Furthermore, a vast and diverse country such as India, with its complex federal system of governance, takes time to understand.
But for domestic and international investors, Modi must now tackle the challenge of cutting fuel subsidies, allowing more foreign investment and pushing through projects that had been stalled due to delays in approvals.
He campaigned on his record of delivering economic growth as chief minister of Gujarat state and the population is impatiently awaiting such change. Thus far, the new administration has done just enough to harness the positive momentum by indicating directional change.
But critical to achieving success in the longer run is the identification of a plan of action that involves quickly plucking low-hanging fruit but also getting started on more fundamental reforms. Effectively, the new government needs to identify “quick wins” and “game changers” and prioritise the execution of these reforms accordingly.
One such game changer would be the goods and services tax. It is India’s most ambitious indirect tax reform, which would replace existing state and federal levies with a uniform tax, boosting revenue collection while cutting business transaction costs. The tax, which could boost India’s economic growth by up to 2 percentage points, has faced resistance from various states, including those governed by the BJP, which fear a loss of their fiscal powers. The reform needs broad backing because it requires a change in the constitution.
Another game changer would be progress in tackling subsidies. Subsidies cost an estimated 2.2 percent of India’s gross domestic product (GDP) in 2013/14. The BJP also wants to reform labour laws to boost job-intensive manufacturing and create as many as 10 million jobs a year for young Indians entering the workforce.
Expectations ahead of the new government’s maiden budget in July were for a reform-oriented document that would focus on the dual goals of fiscal prudence and reviving investment.
Clearly, fiscal stress has constrained the government from undertaking bold reforms and meant the budget was limited to small but directional changes, in what the new government called “the beginning of a journey”. Jaitley’s budget plucked some lower-hanging fruit.
First, by sticking to the path of fiscal consolidation (maintaining the deficit target of 4.1 percent of GDP) along with the formation of the expenditure management committee and, second, by providing incentives to infrastructure and capital investment through measures such as raising the foreign direct investment limit to 49 percent from 26 percent in defence, manufacturing and insurance.
After achieving unprecedented growth of over 9 percent for three successive years between 2005 and 2008 and recovering swiftly from the global financial crisis of 2008 and 2009, the Indian economy has been going through challenging times, culminating in GDP growth of less than 5 percent for two consecutive years. With the “feel good” factor now having returned, the pressure is on for the new BJP administration, and in particular on Modi, to deliver. But questions remain over how much he can realistically achieve and how fast he can do so.
The next six months and the 2015 budget are likely to be the litmus test for the new government, which will have to show some tangible progress on policy reforms or risk facing a reversal of the positive momentum that has characterised the country since the election.
Ronak Gopaldas is the head of country risk at Rand Merchant Bank.