The question facing India in 2018 will be whether Prime Minister Narendra Modi can do for the economy what he has done for his ruling Bharatiya Janata Party. Since blazing onto the national stage four years ago, after more than a decade as a high-profile chief minister of the western state of Gujarat, Modi has led the BJP to impressive victories.
The win in the parliamentary elections of 2014 has been followed by others in nearly a dozen state assemblies-the latest two in December in Gujarat and Himachal Pradesh.
The main opposition party, the once-dominant Indian National Congress, has been reduced to a rump in Parliament, and rules just two major states. Smaller regional parties govern the rest.
But this impressive show is not matched by Modi's economic record. While inflation and the trade and fiscal deficits have been controlled, the average gross domestic product growth rate of 7.3% under Modi is fractionally short of the 7.5% achieved by the predecessor Congress government, led by Manmohan Singh.
The economic underperformance could have serious political implications for Modi, as he prepares for other state elections and a national parliamentary poll in 2019. While 2018 should see a modest economic upswing, a sustained increase requires bold reforms of a kind that the prime minister may be reluctant to implement so close to the next national election.
Calendar 2017 has been Modi's slowest because of the disruptions caused by two government initiatives: the overnight cancellation in November 2016 of high-value notes that accounted for 86% of the total currency, to be replaced by new notes over a period of some months; and the launch in July of a needlessly complicated goods and services tax (GST) that replaced dozens of state and central taxes.
The GST, which Modi announced with typical verbal flourish as a "Good and Simple Tax," has turned out to be anything but simple because of multiple rates and complex compliance requirements that have affected small businesses and exporters in particular. The demonetization a few months earlier was designed to tackle unaccounted flows of money in the system, but hit cash-fuelled sectors including construction, housing and the large informal segment of the economy composed of largely many small family-based enterprises.
The result of the "twin shocks" has been that year-on-year quarterly growth rates slid from 7.5% in July-September 2016 to a low of 5.7% in April-June 2017 before a partial recovery to 6.3% in the July-September quarter of 2017. Jobs have been lost even as new ones have been scarce. Remarkably, the ruling BJP managed to win five of the six states that went to the polls in the midst of the turmoil.
Looking to 2018, all the signs suggest that the worst of the disruption is over and that growth will recover. Sectors like automobiles and aviation have been growing well; export growth in April-November picked up to reach 12%, including a 30% surge in November. The International Monetary Fund forecasts 6.7% GDP growth for 2017, accelerating to 7.4% and then 7.8% in subsequent years. The worry points are two: rising oil prices (India imports most of its crude) and a surge in domestic food prices. These could spur fresh inflation, which has been under control at lower than the central bank's target of 4%, and also affect the continued growth of consumption-which in the absence of much new investment in the economy has been propping up overall demand.
Full-scale recovery hinges on corporate restructuring and debt reduction. There must be progress by troubled business groups such as Essar, the conglomerate, and companies run by businessman Anil Ambani in tackling the heavy debt on their books, and progress by banks in dealing with a flood of bad loans.
Bank lending to industry declined in 2016 and has been stagnant in 2017. Fresh credit growth will be facilitated when the government provides a promised 2.1 trillion rupees ($32 billion) as fresh capital for public sector banks, which more than their private sector counterparts have had to provide heavily for nonperforming and stressed assets, affecting their capital adequacy. Meanwhile, a new bankruptcy law passed in 2016 has gone operational and will help resolve cases of bad debt more quickly than in the past -- thereby helping to clean up a clogged credit system and also improve the credit culture.
For an economy that has seen growth slip below 7% in four of the last seven years, compared with just once in the previous eight years, the challenge is to get growth back up to 7% and then accelerate if possible to 8 and 9%, matching what some East Asian economies did during their years of peak performance.
Room for growth
At a per capita income of about $1,800 (nominal dollars), India is by far the poorest among the large economies and therefore has plenty of headroom for growth in order to meet basic needs like housing, electricity and transport, as well as to feed demand from a growing middle class. The Modi government has provided incentives for low-cost housing and pushed investment into the fund-starved railways, including for the country's first bullet train project that has Japanese funding and technology. In addition, Modi has assiduously promoted e-governance and the digital economy in general. Mobile data consumption per user has multiplied eightfold in 2017.
The key to accelerating growth is reviving flagging investment. Longer-term growth hinges on radical reforms to free over-regulated labor and land markets, and improving the country's human capital, given that education and health attainments remain substandard. Domestic observers have been frustrated by the lack of action on these fronts. So, while the economy is poised for an upswing, the question of accelerating to 8% growth and more still waits for an answer.
Such reforms would require brave political decisions to tackle vested interests such as labor unions, and complicated land rules that are easily exploited by intermediaries, usually politicians mixed up with developers. Always tricky, such reforms may be almost impossible so close to the next parliamentary poll.
But the lack of economic momentum is beginning to tell on Modi's electoral standing, especially with rural voters. The assembly elections in Gujarat, his home state, in December showed a surprisingly strong performance by Congress. If this is repeated in other state elections, due in the course of 2018, Modi might face the 2019 parliament elections with the danger of losing his absolute majority, and therefore of having to rely on coalition partners for a majority. That, in turn, could make it even harder to tackled difficult economic reforms.
T N Ninan is a columnist and former editor of Business Standard.