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Narendra Modi must stop squeezing India's middle class

Rent-seeking policies end up slashing disposable income and capping demand

| India
Shoppers in Kolkata, pictured on Oct. 13: Modi government's policies are putting the squeeze on India's middle class.   © NurPhoto/Getty Images

Ritesh Kumar Singh is chief economist of Indonomics Consulting and a former assistant director of the Finance Commission of India.

A major attraction for international investors looking at India in recent years has been the country's fast-growing middle class, which is estimated to include up to 350 million people.

However, consumption, which was once a major driver of the economy, now looks more like a deflating balloon as companies selling discretionary goods and services are reporting lower sales.

But instead of nurturing this vital sector back to life, India's Prime Minister Narendra Modi -- whose economic credentials were supposed to work wonders for growth -- has chosen a path of maximum political expediency that favors rent-seeking, but is actually hurting his most vocal supporters: the relatively affluent middle class.

So let's pinpoint how Modi government's policies are putting the squeeze on India's middle class

Firstly, Modi halved corporate income taxes, but kept personal income taxes unchanged. That not only encourages tax avoidance by large businesses, it also puts households at a massive disadvantage, adversely affecting their ability to buy goods and services.

It is not difficult to understand that high rates of personal income taxes reduce people's disposable income, and in turn their purchasing power. For many middle income earners, those goods and services they want to buy have now been put out of reach due to the outrageously high goods and services tax.

Take motorbikes and cars, where taxes now add as much as 50% to the purchase price. On top of that, federal and state taxes currently add up to 200% to the cost of buying diesel and petrol, while motor vehicle insurance and car servicing attract an 18% GST rate.

A Suzuki two wheeler showroom in Kolkata, pictured on Sept. 12: taxes for motorbikes and cars add as much as 50% to the purchase price.   © NurPhoto/Getty Images

While most Indians dream of owning their own homes, federal and state governments have been raising costs for homebuyers by not only restricting the supply of available land, but also by slapping a whopping 28% GST on building materials such as cement, bathroom fittings and wall papers.

Modi has ramped up protection for India's already well-nourished steel producers -- helping some large manufacturers -- but hurting would be home buyers, as well as those people wanting to buy a new car or home appliance.

Then there the millions of people who have already bought a home but have not been able to move in because the building is not ready. They are being forced to pay off their mortgages and keep paying rent for the houses they actually live in. And the reason their homes are unfinished? Because so many real-estate developers lack the funds to finish their housing projects after blowing all their money on speculative land deals.

To be fair to Modi, he has at least tried to rein in unscrupulous property speculators with a tight regulatory regime. The problem is, the regulations were badly designed and the implementation has been awful. In the end, buyers are still left to fend for themselves in a country where enforcing contracts is next to impossible -- as reflected by the fact that when it comes to ease of enforcing contracts, the World Bank has India ranked at 163.

Under-investment in public goods such as education and health care is another thing forcing middle income households to opt for expensive private sector options, further squeezing what money they have left to buy anything else.

Then there are the raised import duties on 3,600 tariff lines that Modi has introduced since his 2014 election, with more and more merchandise still being added to India's restricted import list. This growing inward orientation in the name of promoting self-reliance may help lazy domestic manufacturers, but it ends up making it harder for middle income households to buy things like laptops, mobile phones, and air conditioners.

Lower interest rates may have helped Modi's debt-laden cronies pare down the cost of servicing their loans and borrow more money for share buybacks to pump up share prices. But in a country where bank deposits remain the most important instrument of financial savings for middle-income households, record low-interest rates have created a negative wealth effect.

India's slowing income growth and reduced savings, and higher expenses for essentials such as health care, housing, education, and transport, are crushing India's middle class and impacting the country's overall demand for goods and services. This dire combination is hitting private investment as well.

The one thing Modi has excelled at is doling out freebies. Lifting the purchasing power for the poor has no doubt been helpful, but it has mostly supported demand for essentials such as food and clothing. That is vital, but it is not enough.

It is India's relatively affluent households who drive demand for high value discretionary items such as bikes, cars, recreation services and homes. Unless they get relief on the direct and indirect taxes they have to pay, then household demand will continue to founder. The increasingly protectionist global macroeconomic environment is not doing much for India's export prospects and will continue to impact long-term growth rates.

To keep growing, India needs to get serious about boosting domestic demand. You would think that addressing India's demand slump would be Narendra Modi's topmost priority. Unfortunately, he seems more interested in protecting big business interests that dominate the stock market and financial press. Under those circumstances, turning India into a $5 trillion economy will remain a pipe-dream.

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