Modi: Time for a Reboot?

There’s a saying that after the moon of honey, comes the moon of wormwood. For Indian Prime Minister Narendra Modi, 2014 was the moon of honey: He won a spectacular general election victory and then his party, the Bharatiya Janata Party( BJP), won in several state elections. The stock market boomed and foreign investors poured into India. Alas, 2015 was the moon of wormwood. Modi’s party was thrashed soundly in two state elections and failed pathetically in attempts to enact new laws on issues he claimed were critical. Meanwhile corporate results turned ghastly, the stock market crashed to below pre-Modi levels, and Hindu-Muslim tensions strained the social fabric.

Modi has time enough to recover lost ground and win re-election in 2019. But for that he must become a much tougher reformer, and learn to woo sundry regional parties whose support is crucial for him to pass bills in the Rajya Sabha, the upper house of parliament.

In 2015, Modi spent much time and energy on personally leading election campaigns in Delhi and Bihar. He avoided radical reforms that might have antagonized voters in state elections, and banked instead on the charisma and rosy promises that won him the 2014 general election. This strategy failed miserably. In Delhi, where he won all seven seats in the 2014 parliamentary election; he won only three out of 70 seats in the state election. In Bihar, where his alliance won 31 of 40 seats in the Parliamentary election, it won just 58 of 243 seats in the state election.

Two of Modi’s major legislative initiatives last year suffered setbacks: one to make land acquisition easier and the second to create a Goods and Services Tax (GST) to replace the current maze of central and state taxes. At one point he issued no less than seven new laws by decree, a risky move since the Constitution provides that such decrees will lapse unless ratified by the next session of parliament. He failed to get parliamentary sanctions for some of these decrees (including one on land acquisition), a humiliation that eroded his strong-man image.

Modi’s coalition is well short of a majority in the Rajya Sabha, the upper house of parliament, which is elected by members of state assemblies (where small regional parties hold a big chunk of seats). Having failed to bulldoze his way through the upper house in 2015, Modi needs to switch tactics and attempt to woo regional parties. He also needs to forge alliances with regional parties for future state elections.

Economy

The Indian economy looks better viewed from afar than it does from New Delhi. The IMF estimates that Indian GDP growth will accelerate from 7.3 percent in 2015-2016 to 7.5 percent  next year, making the country the fastest growing major economy in the world, overtaking China’s projected 6.8 percent growth. India is a net commodity importer, especially of oil, and has benefited from the global commodity crash. It is not part of the manufacturing value chains linking other Asian economies to China, and so has escaped the consequences of China’s industrial and export slowdown. This helps explain India’s resilience. The IMF and World Bank are among India’s biggest cheerleaders.

But businessmen in India have long faces, and the overall mood is sour. Some economists say that official GDP figures are unreliable following a revision of statistical methodology. Corporate quarterly results plunged through most of 2015, though falling input prices helped improve profits for many companies even as sales stagnated. Moreover, exports have fallen 14 months in a row. Fresh investment proposals declined over the last quarter, and the number of stalled projects increased.

Meanwhile, Indian banks are loaded with dud loans, especially loans for infrastructure and steel, and Reserve Bank Governor Raghuram Rajan has forced them to clean up their books and provide for up to 8 trillion rupees (approximately $116 billion) of impaired loans. Massive write-offs of 400 billion rupees in the latest quarter alone constitute the biggest quarterly bank losses in history, and the carnage will continue next quarter. This cleanup is overdue, and means bank credit is going nowhere fast. The government will have to find huge sums to recapitalize the 70 percent of the banking system that it owns. Combined with chilly economic winds sweeping across all emerging markets, this means that Modi’s 20 months have seen a fall, not a rise, in the stock markets that once boomed.

Modi will gain on two important fronts in 2016. First, India suffered serious droughts in 2014 and 2015 due to El Niño, which is now withdrawing. So India is likely to have a good harvest this year, relieving rural distress and boosting rural spending. Second, on the political side, Modi and his allies may gain 17 or 18 seats in the upper house after elections for a third of the seats in April and May. This will still leave Modi short of a majority, but the rival Congress alliance will no longer, on its own, be able to block the two-thirds majority needed for the Constitutional amendment authorizing a Goods and Services Tax (GST). If Modi can win over key regional parties – and many of them have already given their assent – the GST may pass this summer. That will be a major breakthrough, creating for the first time an India-wide market with uniform tax rates.

However, Modi will not get the support of regional parties for land and labor reforms. His strategy, therefore, is to persuade willing state governments to enact their own reform laws and ensure presidential agreement. Some states have already made hire-and-fire easier, and eased rules on contract labor. Some have also found ways to avoid compulsory land acquisition. Instead, these states have persuaded farmers to surrender their land in return for a share of the developed land after project completion, which will raise land values tenfold.

Meanwhile, the term of central bank governor Raghuram Rajan is set to end in August and Modi must persuade him to serve a second term. A financial storm is brewing across emerging markets and Modi needs Rajan to steer India through that storm. Rajan has high credibility with international markets. He has also not hesitated to air differences with the government. The Finance Ministry would like lower interest rates to spur industry, but Rajan says it is more important to fight inflation and thus to lower rates only gradually. Many industrialists want a big rupee depreciation to spur exports, but Rajan says that will also increase import prices and hence inflation. Some economists want India to abandon fiscal consolidation and go for a fiscal stimulus, but Rajan opposes that too, saying that fiscal credibility is more important. Modi needs to give way to Rajan on all these issues and must persuade him to stay on for a second term.

What long-term trends are evident after nearly two years of Modi’s rule? One is a change in election strategies. Historically, politicians believed elections were best won by offering freebies, subsidies and job reservations to different voter groups. Modi in 2014 took a new approach, emphasizing economic development and good governance rather than handouts. He had his pulse on a new India that wanted more than subsidies and aspired to good jobs in a fast-growing economy. Indian voters are generally cynical about the claims of politicians, but Modi had the charisma and track record in Gujarat, where he had ruled for 12 years, to convince them he could deliver.

However, Modi’s rise to power horrified Indian liberals of all shades, who viewed him as having stoked or connived with Hindu radicals who killed a thousand Muslims in horrifying riots in 2002. Modi was personally exonerated by a Supreme Court-appointed special investigation team, but remains suspect in the eyes of many secular liberals. Communal tensions rose after Modi was elected, tied to the case of a Muslim who was killed by a Hindu mob for supposedly eating beef (the meat was actually mutton), but there have been no major Hindu-Muslim riots during his tenure. Still he has often been too late in speaking out against communal incidents, and has not reined in his colleagues, who have indulged in what is sometimes close to hate speech. Some members of his party think they will gain votes by stoking Hindu-Muslim polarization. Modi must remember that he was elected on a platform of economic dynamism and clean government, and keep that focus.

Above all, over his first 20 months, we have seen that Modi has proven to be an incrementalist, not a radical reformer. For all his talk of “maximum governance, minimum government” he has done nothing dramatic to reduce the role of the Indian government. As the chief minister of Gujarat, he aimed to improve the performance of public sector corporations, not privatize them, and he is following a similar approach in New Delhi. He initially suggested structural reforms to convert two inefficient behemoths, the railways and port trusts, into corporations whose shares would be sold to the public, improving accountability and bowing to commercial sense. But he backed away when trade unions threatened to protest.

At international trade negotiations, he has shown no sign of changing India’s old quasi-protectionist tone. Additionally, Indian companies have complained of Chinese dumping, but to protect the steel industry, Modi has opted for minimum import prices for 173 categories of steel and not for a World Trade Organization-compliant anti-dumping duty. This creates red tape and corruption opportunities. Similar minimum import prices for different varieties of aluminum and copper are being considered. These need to be replaced by anti-dumping duties permitted by the WTO.

An excellent slogan slinger, Modi has rebranded and expanded old Congress programs to pass them off as his own – Swachha Bharat (for better sanitation), Jan Dhan Yojana (banking and overdraft facilities for every household), Make in India (to step up manufacturing), Digital India (to ensure connectivity for all), Smart Cities (for urban modernization), and so on. Rebranding sound old strategies makes sense, but even better would be a new crop of more radical reforms. Incrementalism has political advantages in the short run. It minimizes losers from reforms, yet may cumulatively add up to something substantial over five years. That is Modi’s strategy right now. It is plausible, but may not be enough given the challenges facing India.

Successes

Credit is due to the prime minister. Modi can credibly claim to have improved governance and curbed corruption. The speed of decision-making has improved, though too much power remains centralized in the prime minister’s office. Despite opposition party attempts to pin petty corruption charges on some of his ministers, Modi has ended big corruption. Minor corruption and state-level corruption continue, of course, but top businessmen all say big corruption is gone. India’s rank in Transparency International’s Corruption Perception Index has improved from 85th to 75th accordingly.

Furthermore, the old “social contract” between politicians and businessmen that provided licenses and sweetheart deals for kickbacks has started to crumble. The combined impact of anti-corruption protests, media exposés, and Supreme Court directives helped Modi come to power, and also created structural changes that have broken the old social contract. Natural resource allotments are now done transparently through auctions, and not through discretionary favors. Modi oversaw the enactment of a law to ensure the auction of not just scam-ridden coal and spectrum, but all minerals (such as iron ore, limestone, granite, and bauxite). These changes are not reversible by future governments; they are structural changes that will improve productivity and competitiveness. India’s latest ranking in the World Economic Forum’s Global Competitiveness index is as a result up from 71st to 55th.

Improving the ease of doing business in India has been a major focus for Modi. This is essential to deliver on his election plank of accelerating development and jobs. On coming to power, he pledged to improve India’s position in the World Bank’s Ease of Doing Business ranking from 142nd in the world to 50th. The latest Bank report shows India rising to 130th. Moreover, Modi has succeeded in creating competition between the states to improve business conditions. A new bankruptcy law makes it easier for banks to seize assets of defaulters and auction them. Earlier, cronies enjoyed never-ending debt forgiveness. The Supreme Court has also decided to intervene to check easy (and sometimes corrupt) debt forgiveness. This, again, is a welcome structural change.

Modi’s coming to power coincided with a disruptive trend that is sweeping the world, and will change India too. The rise of “unicorns,” many of which are Internet-based start-up companies, could improve consumer satisfaction and empowerment in unexpectedly new ways, and could demote or destroy traditional business giants. New Indian companies like Flipkart, Snapdeal, Ola Cabs, Make My Trip, and others carry huge market valuations in the billions of dollars, though they have yet to prove their profitability. Like Google, Facebook, and Uber in the United States, or Alibaba and Tencent in China, Indian companies of this genre are flying very high. Modi aims to promote this trend through his Start-Up India campaign, and create more new global “unicorns.”

Finally, Modi is moving toward a new subsidy approach that can hugely improve government finances. For decades, subsidies of all sorts have proliferated – for food, kerosene, diesel, electricity, canal water, cooking gas, fertilizers, railway transport, jobs, small industries, backward areas, hilly areas, and so on. Countless studies have shown that subsidized schemes are leaky, corrupt, and ineffective. It takes three rupees of spending to get one rupee to a poor person and many poor people do not get the supposed benefits at all. Yet politicians at the central and state level have always competed in offering ever-more subsidies on ever-more items. Modi is attempting to replace subsidies on goods and services with cash transfers. He has already accomplished this for cooking gas. He has abolished the subsidy on diesel, taking advantage of the fall in global oil prices. Pilot projects are attempting cash transfers in lieu of subsidies on kerosene, fertilizers, and maybe even food, the ultimate sacred cow in the realm of subsidies. This has enormous potential for reducing waste and corruption.

But urgently needed administrative reforms are not keeping pace. The bureaucracy is woefully short-staffed at the top, and lacking in domain expertise. Modi needs to systematically induct high-level experts from outside in every ministry and state. He must hugely expand judicial and police posts to deal with court arrears of millions of cases. Digitization and e-governance can help, but they must be backed by a new bureaucratic culture emphasizing the rights of citizen to quick, clean government services. Modi talks a lot about citizen empowerment, but little has changed at the ground level.

He has not attempted to improve the pathetic government delivery systems for education, health, and other basic services. Most of these are delivered by state governments and Modi cannot order them to reform, but he can certainly push them. High teacher absenteeism means that little teaching occurs in free government schools, so desperate parents are shifting to expensive private schools. Primary health centers lack both staff and medicines. Nutritional programs are a joke. Economists Amartya Sen and Jean Dreze say that of all fast-growing economies, India’s social indicators – for education, health and nutrition – have improved the least. Even as India’s private corporations steadily become world-class, government services remain as third world as ever. Even poorer neighbors like Bangladesh and Nepal have overtaken India in some social indicators. Drastic reforms are required, but none are in sight.

Economist Daron Acemoglu from the Massachusetts Institute of Technology and political scientist James A. Robinson from Harvard University, in their seminal book Why Nations Fail, showed that the quality of a country’s institutions – including not just statutory bodies, but norms, values, and commitment to citizen welfare – ultimately determine whether a nation succeeds or fails. Many poor countries have managed rapid economic growth in their initial stages, even with weak institutions of the sort India has. But once a country enters middle-income status, as India has, it must improve its institutions or suffer economic slowdown. Doing the simplest economic reforms has already achieved results in India, but the future depends on creating strong, meritocratic institutions that are not subverted by money, muscle and influence. That is a long and difficult agenda.