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Topic: Economy
Region: South Asia
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Vasily Shikin

Ph.D. in History, RIAC Expert

The Narendra Modi Government, which came to power in India in May 2014, promised to carry out sweeping reforms and speed up India’s economic growth. Over the last year, the reformist government has managed to regain for India the status of one of the fastest growing economies in the world. Yet it is still early days to speak about the reform being a success.

The Narendra Modi Government, which came to power in India in May 2014, promised to carry out sweeping reforms and speed up India’s economic growth. Over the last year, the reformist government has managed to regain for India the status of one of the fastest growing economies in the world. Yet it is still early days to speak about the reform being a success.

It can safely be said that 2015 will leave many unpleasant memories in BRICS countries. The Chinese “new norm”, the politically correct term used by Xi Jinping to describe the slowdown in China’s growth, has sent the stock market plummeting by 40% and threatens a debt crisis [1]. The structural problems in the Russian economy, compounded by the falling oil prices, have led to a sharp devaluation of the rouble and caused the budget to be revised. Brazil’s economy is paralysed by anti-corruption purges [2] , and South Africa is teetering on the brink of recession, thus failing to justify its inclusion in BRICS [3].

Against this gloomy background, the performance of the Indian cabinet under Narenda Modi in its first year looks more than promising. India’s GDP growth leapt by 7.3% in FY 2014-2015 [4] , outstripping even the Chinese economy in the last quarter of 2014. The trend looks set to continue, according to the World Bank, so that, by as early as 2017, India may become the fastest growing BRICS economy [5]. The government has also managed to cut inflation from 11.2% to 5.1%, and the budget deficit from 4.6% to 1.3% of GDP and to increase the sovereign wealth fund to a record $334 billion [6]. The Indian stock market was quick to react: the SENSEX index grew by 25% during the year, one of the fastest growth rates in the world [7]. Against the backdrop of deteriorating economic performance by BRICS countries over the last year, how did the new Indian government manage to put the economy right and regain the confidence of international investors?

Flying start

It can safely be said that 2015 will leave many unpleasant memories in BRICS countries.

Few outstanding reformers have stayed in power long enough to see the results of their transformations. Narendra Modi has been luckier than many of his predecessors. During his tenure as governor of Gujarat State, he turned it into a locomotive of the country’s economic growth. Modi was able not only to enjoy the results of his reforms, but earn the recognition of his contemporaries (which happens even less frequently in the lifetime of reformers) and lead his BDP party to victory in the federal elections, thus getting a mandate to repeat the Gujarat miracle on a nationwide scale. The paradox of the reform programme proposed by Modi is that it yielded fruit as soon as the new Prime Minister began implementing it.

modibharosa.com
Infographics. PM Modi lauched major labour
reforms schemes

Upon assuming office in May 2014, Modi unveiled the most ambitious programme of economic transformations since 1991, the aim being to speed up economic growth. December 2014 saw the start of a campaign to stimulate development of priority industries and attract investments into the economy under the slogan “Make in India,” an obvious challenge to the much-touted slogan “Made in China” and hinting at India’s ambition to grab from the latter the title of workshop of the world. Under the programme, the new government raised the ceiling for foreign capital participation in the insurance and defence spheres from 26% to 49%, lowered the barriers to investment in the building sector and allowed foreigners to own railways. As a result, the inflow of foreign investment in FY2014/15 increased by 48.3% over the previous year and the companies that came to India during that period included such big names as General Motors, Daimler, the Chinese Xiaomi Inc and Taiwanese Foxconn [8].

By as early as 2017, India may become the fastest growing BRICS economy.

Attracting capital is impossible without improving the investment climate. In 2014, India held a humble 142nd place in the World Bank’s “Ease of Doing Business” rating [9]. Modi promised to lift India to 50th place during his term as Prime Minister. To this end, a state internet portal called eBiz was launched, this cutting the time it takes to do all the paperwork and register a business and initiating an infrastructure development programme. The government plans to create about a hundred “smart cities,” link them by high-speed railways and industrial corridors. The current state of the power industry and the clapped-out network infrastructure cannot support the 8% GDP growth envisaged under the last federal budget [10]. Consequently, the state tried to de-monopolise the coal sector and launched an ambitious alternative energy source programme. Before 2022, India is committed to connect to the power grid 100 Gw of solar and 60 Gw of wind power plants [11]. Although, at first glance, these targets are impossible to achieve within such a short space of time, during the past year, India has become a veritable Klondike for power companies from across the world and daily tenders for setting up solar panels and wind farms have become the norm.

This only begins the list of economic issues the new Prime Minister grappled with during his first year in office. The problem is that all these changes are more cosmetic in nature and are not enough to get rid of the fundamental problems that piled up during the years of command-and-administer regulation, which are preventing India from tapping its full economic potential.

Combating tax feudalism

REUTERS/Adnan Abidi
Labourers work at the construction site of
a residential complex in Noida on the outskirts
of New Delhi, India, August 20, 2015

One such problem is the Indian system of indirect taxes, which has never been streamlined since independence. Because Indian states have the right to introduce their own taxes, the goods and services moving across their borders are taxed many times over at various stages of production and marketing, which dramatically raises the cost of the supply chain. The Modi government has proposed to replace all the indirect state and federal taxes with a single Goods and Services Tax (GST) to be set by Delhi and to be levied only on added value, which should eliminate the problem of multi-stage taxation and make production in India more attractive.

To change the tax system, the government will have to make amendments to the Constitution, which means that it will have to enlist the support of two-thirds of the MPs and at least one-third of Indian states. The constitutional amendment has already been approved by Lokh Sabha (the lower house of parliament), while the Rajya Sabha (upper house) has yet to give its final approval. In general, according to the Ministry of Finance, in administrative terms India is ready to switch to the new taxation scheme as of 1 April 2016.

Paradox of the reform programme proposed by Modi is that it yielded fruit as soon as the new Prime Minister began implementing it.

Yet there are still few grounds for optimism, as Modi’s biggest problem will be to win over the authorities of the various states. Industrialised producer states, including Modi’s home state of Gujarat, are not interested in the reform because, under the current law, tax is collected at the place of production while, under the amendment, it would be collected at the place of sale, that is, when goods are sold to another state, the tax would settle in the budget of the consumer state. To make the producers more amenable, the government has proposed a temporary additional 1% tax on trade between states for redistribution in favour of the producer states. In addition, the single tax will not cover such consumer goods as alcohol and tobacco. Without these concessions, the draft amendment would have no chance, yet they bring into question the economic effect of the reform because it would still leave tax barriers in trade between states, albeit not as significant as before.

The land issue

REUTERS/Anindito Mukherjee
Vasily Shikin:
The Budget of Disappointed Expectations

The Modi government has discovered that its ambitious infrastructure and industry reform plans would be hard to implement without amending the law on land acquisition. The current law envisages mandatory evaluation of the social impact of a land purchase deal and requires the consent of at least 80% of the former owners for private projects and of at least 70% if land is purchased under a public-private partnership scheme. Under the current law, the compensation to the former owner exceeds the market value of the land plot. The Modi government has proposed to exempt from the current law five groups of projects: military projects, rural infrastructure construction, affordable housing, industrial corridors and infrastructure facilities.

In December 2014, without waiting for the consent of parliament, the cabinet introduced temporary changes in the current land legislation by presidential decrees (a procedure allowed under the Indian Constitution) and submitted the draft law to parliament. Lokh Sabha, dominated by the ruling BSP party, approved the bill striking infrastructure projects off the list of exceptions because they lend themselves to loose interpretation. Even so, the upper house of parliament turned down the bill because the opposition majority there thought it was aimed against peasants. Having failed to secure parliamentary endorsement, the Modi government twice initiated reissue of the decree amending current legislation. Yet, on 31 August 2015, when the decree was up for renewal again, after a six-month stand-off in parliament, the Prime Minister announced that the government would not extend it bypassing parliament. Modi also declared that his government would change its approach to the land issue to make the law more acceptable to peasants.

Problem is that all these changes are more cosmetic in nature and are not enough to get rid of the fundamental problems that piled up during the years of command-and-administer regulation, which are preventing India from tapping its full economic potential.

The government will not abandon its attempts to change the land law but giving up the initial form of amendments is the most significant political setback for Modi to date. The land purchase law is central to the Indian government’s economic agenda because renunciation of the proposed amendments threatens to wreck the entire reform programme. Implementation of all the above-mentioned programmes, including Make in India, “smart cities,” industrial corridors, high-speed railways and new energy capacity, hinges on acquisition of land for these projects. The current land law increases the cost of infrastructure projects many times over, scaring off private investors or making the projects totally impossible. Not surprisingly, engaging his opponents in parliament in a war of words, Modi accused the opponents of the new law of being opposed to economic growth. What has made the Prime Minister sharply change his rhetoric and seek a compromise? Apparently, it was not so much the resistance from the opposition as pressure from his fellow party members. India is entering a new political cycle and BDP is girding itself for an electoral race in states where the outcome may be crucial. Success may win Modi’s supporters a majority in the upper house and break the stalemate over the legislative initiatives proposed by the cabinet. In the event of failure, the political crisis may drag on and the work of parliament be paralysed. The opposition accuses Modi of lobbying for the interests of corporations and the bill is anything but popular among the rural folk, who account for nearly 70% of the electorate, too many to be neglected in the run-up to the elections.

Time to deliver

All the reforms that could really give a new impetus to an economic spurt, including revision of the tax system and of the land purchase procedure, are in a suspended state. There is not much hope that Modi will manage to break the deadlock.

The Indian Prime Minister has accomplished a great deal during his first year in office but launching programmes to stimulate growth and fight red tape is not enough to turn India into a new workshop of the world. All the reforms that could really give a new impetus to an economic spurt, including revision of the tax system and of the land purchase procedure, are in a suspended state. There is not much hope that Modi will manage to break the deadlock.

In its victory in the May 2014 elections, the BDP won an absolute majority in the lower house of parliament, which enabled it to get its new laws through the lower house with comparative ease, yet the ruling party failed to agree with the upper house on the most fundamental issues. Nor has the current government managed to derive many dividends from the current economic situation in the world. Contrary to expectations, the government decided against taking advantage of falling oil prices and relieve its budget of the burden of fuel subsidies, which are eating up about 0.5% of India’s GDP [12].

The Modi government owes its promising economic indicators in its first year in office largely to the high expectations of investors who appreciated the new cabinet’s zeal for radical change and have been willing to give it the benefit of the doubt. In future, however, high hopes and a commitment to change will hardly suffice to pay for high expectations, the euphoria from the announced reform programme is wearing off and the Indian economy will need not a facelift but a thorough overhaul if it is sustain its achievements next year.

1. Foreign Affairs, Zhiwu Chen, China’s Dangerous Debt, Vol. 94, Number 3, May – June 2015 // https://www.foreignaffairs.com/articles/china/2015-04-20/chinas-dangerous-debt

2. The Wall Street Journal, S&P Cuts Brazil’s Debt Rating to Junk, 5 September 2015 // http://www.wsj.com/articles/s-p-drops-brazil-debt-rating-one-notch-to-junk-1441838102

4. Bloomberg, South Africa’s Economic Woes Worsen as GDP Contracts 1.3%, 25 August 2015 // http://www.bloomberg.com/news/articles/2015-08-25/south-africa-s-economic-woes-worsen-as-gdp-contracts-1-3-

4. The Economic Times, Q4 GDP Grows at 7.5%; Economy Grows at 7.3% in FY15, 30 May 2015 // http://economictimes.indiatimes.com/news/economy/indicators/q4-gdp-growth-at-7-5-economy-grows-at-7-3-in-fy15/articleshow/47471403.cms

5. The Wall Street Journal, World Bank: India to Become Fastest-Growing Big Economy, 14 January 2015 // http://blogs.wsj.com/indiarealtime/2015/01/14/world-bank-india-set-to-become-worlds-fastest-growing-big-economy/

6. The Hindu, Full text of Budget 2015-16 Speech, 28 February 2015 // http://www.thehindu.com/news/resources/full-text-of-budget-201516-speech/article6945026.ece

7. The Times of India, Sensex Makes 25% Gain in 2014-15 // http://timesofindia.indiatimes.com/business/india-business/Sensex-makes-25-gain-in-2014-15/articleshow/46764894.cms

8. J.P. Morgan Asset management, India and Mr. Modi: A Progress Report, 31 July 2015 // http://insights.jpmorgan.co.uk/adviser/commentary-and-analysis/market-insights-india-and-mr-modi-a-progress-report/

9. The World Bank, Ease of Doing Business Index, 2014 // http://data.worldbank.org/indicator/IC.BUS.EASE.XQ

10. The Hindu, Full text of Budget 2015-16 Speech, 28 February 2015 // http://www.thehindu.com/news/resources/full-text-of-budget-201516-speech/article6945026.ece

11. Clean Technica, India Aims For 350 Gw Renewable Energy Capacity By 2030, 23 September 2015 // http://cleantechnica.com/2015/09/23/india-aims-350-gw-renewable-energy-capacity-2030/

12. CNBC, Why India’s Fuel Reform is a Big Deal, 20 Oct 2014 // http://www.cnbc.com/2014/10/20/why-indias-fuel-reforms-are-a-big-deal.html

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