March 20, 2017 1:00 pm JST
Ritesh Kumar Singh and Prerna Sharma

Election victories no guarantee of reform from India's Modi

Temptation of populist handouts likely to grow

Supporters await the arrival of Indian Prime Minister Narendra Modi for a reception at Bharatiya Janata Party headquarters in New Delhi on March 12, a day after the party’s landslide victories in key state legislature elections. © AP

After a series of spectacular wins in India's recent state elections, notably in Uttar Pradesh, the most populous state, supporters of Prime Minister Narendra Modi would like to pass off the result as a vote of confidence in demonetization. They have projected the initiative, which forced holders to exchange high-value banknotes, as a game-changing reform to curb tax evasion and money laundering and promote digital transactions.

However, a combination of factors seems to have worked for Modi's right-wing Bharatiya Janata Party, giving it one of the biggest electoral wins in the history of Uttar Pradesh, following humiliating defeats two years ago in Delhi and Bihar. Handouts such as free cooking gas, maternity benefits for the poor and the promise of a farm loan waiver boosted the party in the state. It also used communal polarization to counter the caste politics of dominant regional parties and exploited anti-incumbency sentiments. Modi's charisma and unmatched oratory also helped the BJP.

In other words, the election victory should not be considered an endorsement of demonetization. Those who say it was need to explain why a BJP-led alliance in Punjab, another big state, lost heavily.

Nor will the electoral victory necessarily be followed by the "big bang" reforms that India's business community has been hoping for since Modi came to power in 2014. Indeed, it may lead to more populist government policies in the run-up to the 2019 national election.

The BJP's massive wins in Uttar Pradesh and the neighboring state of Uttarakhand, along with good performances in the states of Goa and Manipur, will help it to improve its seats in the Rajya Sabha, the upper house of India's parliament. The party's lack of a majority there has imposed limits on the Modi government's ability to push crucial legislative reform bills in the past. Most of the 245 members of the upper house are elected indirectly by state legislatures, with a few appointed directly by the country's president.

Uttar Pradesh accounts for the largest state delegation in the upper house, with 31 members. The BJP and its coalition control more than half of India's states and are likely to make big gains in biennial indirect elections for 55 Rajya Sabha seats due in 2018. The BJP could gain at least 11 seats, taking its tally to 67 in the upper house, but that would still leave it short of a clear majority.

Crafty campaigner

A comfortable majority is no guarantee of major reforms. The prime minister is a crafty campaigner but his record on the economy has not been so impressive. Growth remains below expectations, even if a questionable computation method for calculating gross domestic product is ignored. Job creation was one of Modi's key election planks in 2014, but the government has failed to deliver.

Investment as a percentage of GDP has declined from 30.3% in the fiscal year to March 2015 to about 26.9% in the year ending this month. Investment in the private sector remains a big worry, despite several interest rate cuts since January 2015.

The promise of double-digit economic growth cannot be fulfilled unless private investment increases. Achieving that target will also require increased public investment, but the share of capital expenditure in total government expenditure remains as low as ever.

Modi's pet infrastructure projects, such as major highways, have not made much progress. He has laid the foundation stones for 11 highway projects since assuming office, yet only two are proceeding on schedule.

There has been progress on a national goods and services tax, an insolvency and bankruptcy code has been introduced, and corruption may have been reduced. But the government has not delivered on tougher policy reforms, especially those dealing with freeing the prices of agricultural commodities, chemical fertilizers and natural gas, or taxing rich farmers. Electoral reforms to curb the use of undeclared cash in politics have been more talked about than acted upon.

Despite plenty of hype about business facilitation, India remains a dismal 130th in the World Bank's global Ease of Doing Business rankings. Most of what has been done to ease the path for business by New Delhi and state governments was positive, but just procedural simplification. Such changes make it easier for investors to comply with official rules, but are not game-changing reforms.

Most foreign direct investment is through private equity deals or mergers and acquisitions. That does not create new assets or jobs, and it is still very difficult to push greenfield projects in India. Moreover, India's policies toward foreign direct investment often come with irritating riders that do not make sense, such as sourcing restrictions that apply to foreign retailers.

Landslide victories

Many optimists think that with landslide victories in Uttar Pradesh and other states, Modi will become bolder in pursuing crucial reforms regarding land and labor markets or in resolving the balance-sheet problems of indebted companies and state-owned banks to support investment and growth. They may be disappointed.

Modi appears to be wary of bold, pro-business reforms that could be portrayed by the opposition as harming the poor, or as a sell-out to the corporate lobby. If we look at the government's last two budgets, a clear focus on rural India, rather than pro-business reforms, is evident.

If the last two-and-a-half years of Modi's rule are anything to go by, bolder reforms are unlikely to come, especially as his new reputation as the friend of the poor seems to be helpful in winning elections. As he focuses on 2019, Modi will not be comfortable with any dilution of his pro-poor image.

Thus, no major reforms should be expected. The privatization of Air India or the creation of a "bad bank" to help commercial lenders' clean up their balance sheets, which would be lambasted by critics as a bail-out for corporate defaulters, will not happen, at least not before the next general election.

Instead, the promised loan waiver and interest-free loans to farmers in Uttar Pradesh will increase financial pressure on India's banking system, which is already troubled by high and rising bad loans. Uttar Pradesh farmers owe 860 billion rupees ($13.1 billion) to public sector banks.

Loan waivers will encourage farmers to postpone loan repayments, in the expectation of further relief in the future. Worse, the move could induce similar demands in other Indian states, especially those going to the polls soon, such as Karnataka.

All in all, having seen that handouts can help win elections, Modi's government is likely to be more populist than reformist in the near future.

Ritesh Kumar Singh is a corporate economist and former assistant director of the Finance Commission of India. Prerna Sharma is vice president and head of agriculture, food and retail at Biznomics Consulting, a research and policy advocacy specialist in Mumbai.

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