To the unrestrained delight of investors and financial markets, Narendra Modi has prevailed in the audition for India’s newest Messiah. The incumbent has been received rapturously, with commentators running out of superlatives and comparisons – Thatcher, Reagan and several Indian gods. The stock market and currency have soared.
But governing will prove more difficult than winning power. Meeting the weight of popular expectations may prove impossible. The new government’s policies remain vague.
Knowing the election was theirs to lose, the BJP did not release its manifesto until late in the campaign. Devoid of detail, it promised greater growth and prosperity, elimination of corruption and removal of business red tape. In a concerted effort to avoid leaving anybody out, it promised assistance to women, rural citizens, the disabled and the disadvantaged. It promised a “Rurban” strategy to supply “urban amenities to … rural areas, while retaining the soul of the village”.
Policy programmes contain internal contradictions. There is a promise to reduce the budget deficit while maintaining current spending, eschewing the difficult task of restructuring large government programmes for rural employment and food security. The BJP favours foreign capital but will protect India’s millions of small grocery shops and traders, disallowing direct investment in the retail sector, approved by the previous government.
The new government’s room for manoeuvre is constrained by India’s economic realities. Growth has fallen below 5 per cent. Consumption is weak. Business investment is 9 per cent of GDP, down from 17 per cent. Major Indian businesses have chosen to expand internationally, rather than domestically.
Industrial output is stagnant with key sectors such as automobile sales weak. The agricultural sector, which has benefited from good rainfall, strong production and high prices, is slowing.
India needs to create about 1 million jobs a month just to absorb new entrants to the workforce. This does not take into account reducing unemployment and under-employment or providing work for people migrating from rural areas.
The lack of a substantial manufacturing sector constrains much-needed job creation. India’s National Manufacturing policy sought to increase manufacturing’s share of GDP to 25 per cent from 16 per cent and create 100 million jobs within the next decade. In fact, India has de-industrialised, with manufacturing declining to 15 per cent of GDP. In the past decade, employment in manufacturing and the large agriculture sector has decreased.
Export demand has picked up, in part due to increased competitiveness following the significant devaluation of the rupee, but remains fragile due to continued weakness in major trading partners. The current account deficit has narrowed, mainly due to lower imports driven by, in part, the previous government’s restrictions on gold imports. But the capital account remains vulnerable with weak capital inflows that are flattered by expensive bank deposits from non-resident Indians.
The deficit remains at 4.6 per cent (even after a liberal accounting), restricting the ability to initiate a major fiscal stimulus package in this week’s budget. With continued pressure on food and energy prices, monetary policy remains focused on combating inflation with limited scope to lower interest rates to stimulate activity.
Banking remains under pressure, constraining the supply of credit. Unresolved bad debts may require recapitalisation of state-owned banks, increasing budgetary problems. The combination of a weak financial system and many highly leveraged infrastructure firms means that raising funds for essential projects will remain difficult.
India faces key external risks over which it has little control, including potential rises in energy prices driven, for example, by the Ukrainian and Middle Eastern imbroglios, capital outflows resulting from further reductions in the US Federal Reserve Bank purchases of government bonds or a ratings downgrade. Investors have forgotten that in 2013 when the Fed chairman raised the possibility of a reduction in bond purchases, Indian financial markets came under sustained pressure.
The structural change agenda remains daunting. Key areas requiring radical reform include land acquisition, labour markets, banking and state ownership of key businesses. Fiscal reform needed includes politically difficult changes in the tax base, including more reliance on sales taxes and review of many poorly targeted subsidy and social welfare programmes. Attempts at significant change have largely defeated successive governments over the past 25 years.
Investors have forgotten that Mr Modi’s less charismatic and less controversial predecessor Manmohan Singh, a professional economist, was once hailed as India’s saviour. He was called the “architect of modern India” and drove important changes that paved the way for strong economic growth. By the 2014 election, he was seen as indecisive,weak and a puppet for interests of the Congress party.
Satyajit Das is a former banker and author of ‘Extreme Money’ and ‘Traders, Guns & Money’