Reviving India’s economy: Modi’s mission | The Economist
Reviving India’s economy
Modi’s mission
The new prime minister has a good chance of resuscitating the country’s underperforming economy
INDIA, a giant economic mediocrity, is cursed by having too many economists. Its outgoing prime minister, Manmohan Singh, has a doctorate from Oxford, ran the central bank in the 1980s and led the liberalisation programme that India put in place in 1991 after a currency crisis. Yet as prime minister Mr Singh had little grip or public support, serving at the pleasure of Sonia Gandhi, the populist leader of the Congress party. By the end of his ten-year term he admitted he had failed. In August, as the rupee tumbled, he addressed a gathering of India’s policymaking elite at his house in Delhi. The economy faced “very difficult circumstances”, he whispered.
Mr Singh’s successor could not be more different. Narendra Modi’s economic views have been formed while running the business-friendly state of Gujarat for the past 12 years. Asked some time ago about his economic influences, he described his homespun framework, jotting diagrams on a pad as he spoke. He has studied Singapore and China, but thinks that “India is a democracy and has different requirements”. Striking a balance between farming, small firms and global companies is required, with limited but muscular administration and populist appeal: “Men, machines and money must work together.”
Having run Gujarat well, Mr Modi now faces the far harder task of running India. He has big advantages—administrative competence, control over his party and a majority in Parliament—that should ease decision-making. Unlike Mr Singh, he has also campaigned and won on a platform of aspiration and economic reform. India needs “less government and more governance”, he declared on the campaign trail.
The immediate situation is precarious, notwithstanding a post-election surge in the stockmarket. India suffers from stagflation. Growth is 4-5%, half the level at the peak, inflation is 9% and rising (see chart), industrial production is declining and the public finances are a mess. Although the current-account deficit has narrowed to below 2% of GDP, it is flattered by a de facto ban on gold imports and could yet blow out to scary levels again.
As
The Economist went to press Mr Modi had not picked his finance minister. The front-runners are Arun Shourie, a journalist and ex-minister, and Arun Jaitley, an urbane stalwart of Mr Modi’s Bharatiya Janata Party. Both are able. As well as dealing with the immediate mess, Mr Modi and his finance minister must grapple with India’s long-term trajectory. It is distinctly wobbly.
A decade ago the country seemed destined to rival China. Annual growth was heading towards 10%. India had the ingredients that had made East Asian countries richer: a growing population and rates of saving and investment of over 30% of GDP that would finance factories and roads, lifting the economy’s potential. Unlike most East Asian counties, India has never had a strong state, but instead, optimists argued, it had brilliant entrepreneurs who could wheel and deal the country to prosperity.
What went wrong? The raw inputs of growth—people and capital—have been deployed badly. The rates of savings and investment have dipped and their mix has deteriorated. High inflation has led households to buy gold, shifting money away from the banking system where it can be productively employed. And a mixture of bureaucracy, excessive leverage, incompetence and corruption has led private companies (whose spending tends to have the most bang per rupee) to halve their investments as a share of GDP. What has been invested has often been tangled in red tape and graft.
India’s improvised miracle has hit its limits. Energy and chaos only go so far. Although poverty has fallen and there are pockets of dazzling wealth, much of the economy is primitive. Infrastructure is decades behind China’s. Industries that are close to the state involve corruption on a grand scale, with bribes paid to politicians and officials over the past half decade of anywhere between $4 billion and $12 billion. Only 3% of Indians pay income tax, leaving a hole in government finances.
About 90% of jobs are informal, leading to widespread poverty. Agriculture is feudal and food shortages cause inflation. India is meant to be industrialising but manufacturing contributes only 15% of GDP and 11% of jobs, and its share has been falling. A majority of India’s 50m manufacturing workers toil in facilities without electricity. A droopy rupee means India has been running to stand still. At market exchange rates India’s GDP remains smaller than Italy’s and ranks tenth in the world, about the same as in the 1980s.
There may be no one better qualified than the forceful Mr Modi to kick-start the investment cycle and slay stagflation. In his first month Mr Modi will beef up the prime minister’s office and knock heads together to get stalled projects moving. Some are embroiled in legal disputes which he will not be able to override; others are a matter for state governments. But still others are easy pickings. Roads, rail, coal and gas are areas where a decisive central government will make a difference, says Sanjeev Prasad, of Kotak, a bank.
Cometh the hour, cometh the man
In his first quarter in office he must tackle the bloated fiscal deficit, which has fuelled high inflation. Book-cooking by the outgoing government means that the true deficit is higher than official forecasts—at perhaps 7-8% of GDP (including the states). Mr Modi will trim spending on wasteful subsidies of fuel and food and defer the rolling out of welfare schemes passed by the last government in its dying days. A budget will offer a chance to reverse the previous government’s retroactive tax claim on Vodafone, India’s largest foreign investor. Doing so would soothe the nerves of foreign firms.
In his first year, Mr Modi must stabilise India’s rotten banks and tame inflation. Recapitalising state-run lenders will cost up to 5% of GDP and will involve taking on the bureaucracies that run them and the powerful industrialists who are sitting on bankrupt projects that need to be written off. It will be a test of Mr Modi’s resolve. Another test will be his stance on interest rates. The boss of the central bank, Raghuram Rajan, wants a tough new inflation-targeting regime. Mr Modi should back Mr Rajan, who is keen to stay in his job. After all, high inflation is partly why Congress lost.
A good first year will revive animal spirits. Ajay Piramal, a tycoon with a billion dollars in gross cash, is now looking to invest again. The election result is “a good sign of the maturing of the electorate,” he says. Within two years the economy could be growing at close to its potential rate. Chetan Ahya of Morgan Stanley, a bank, forecasts growth of 6.8% by the quarter ending in March 2016. If Mr Modi achieves all this, he will have done the easy part.
In the long term he must raise India’s growth rate towards 10% and ensure that expansion starts to generate decent jobs. You do not become a superpower by creating an ever bigger army of underemployed drivers, idle security guards and ragged peons. India’s median age is 26, and every year for the next decade 10m people will enter the workforce. That requires a new vision for India and deeper reforms.
Critics argue that this is a step Mr Modi will be unable to make, and that he offers only a limited form of crony capitalism, with chummy deals struck with tycoons. This is unfair: many firms in Gujarat say that the bureaucracy works well, that the courts are fast and that graft is non-existent. The state has some impressive bureaucrats, ministers and institutions.
In any case India’s new economic plan will have to be home-grown, because simple prescriptions do not work. Outsiders often argue that all India needs to do is open up its economy and shrink its public sector. But the state is too puny in many ways: it is unable to enforce contracts and cannot afford to spend enough on infrastructure. The big impediment to foreign investment is not legal restrictions (most sectors are already open) but the same nightmarish business conditions that annoy local firms.
What might Mr Modi’s long-term plan look like? Some things are obvious. The solution to India’s fiscal problem (it has not run a budget surplus since independence in 1947) is to expand the tax net. A proposed direct-tax code, and a goods-and-services tax (GST), should achieve this. With more revenue, the state can build more infrastructure: the experiment over the past decade of getting the private sector to do the heavy lifting has had mixed results. The GST also helps make India a single market by replacing a myriad of local levies. The bureaucracy needs to be reformed; Bimal Jalan, a former central-bank governor, says the number of ministries should be cut.
But the big question is whether Mr Modi can make India a global hub for labour-intensive manufacturing. Japan, South Korea and China got richer by employing unskilled farmers in factories. The timing is perfect for India. Labour costs are rising in China; Japanese firms are shifting production from China because of military tensions; and the rupee has fallen, making Indian workers more competitive.
Sadly, it is hard to find an Asian boss who is interested. William Fung of Li & Fung, the world’s biggest sourcer of clothes for Western retailers, says activity is shifting to Bangladesh, South-East Asia and Africa. Zhang Ruimin, of Haier, a big manufacturer of household appliances, says he wants to automate his factories in China. Fujio Mitarai, the boss of Canon, plans to tilt production back to Japan and also automate it. When India is mentioned he raises his eyebrows.
About half of China’s exports are made by foreign firms. India could try relying on indigenous manufacturers instead. But they usually prefer to use machines, not employ people. They are also subscale. Mahindra & Mahindra, India’s local car champion, has a research-and-development budget that is 1% of Volkswagen’s.
Some argue that India could rely on a “trickle-down” effect from its sophisticated IT, pharmaceutical and high-tech manufacturing industries. They employ only a few million people but generate exports worth 7% of GDP. As the owners and staff of these firms spend the value added they have earned, they might create jobs.
It may be possible on paper, but some are sceptical that trickle-down can deliver a widespread improvement in living standards quickly. Arvind Panagariya, an economist Mr Modi listens to, argues that such an approach will not transform India. “Manufacturing is of the highest priority…In ten or 15 years’ time India ought to be where China is today.”
Narendra the great mender
Can Mr Modi achieve this? In a technical sense he will have to transform the supply of the inputs of production. Most factories find it far too hard to get land, labour and energy. All three inputs are bound by a mesh of restrictive rules and bureaucracy, vested interests and corruption. One option would be to devolve power over these matters to the states, and hope that they compete among each other to raise standards, much as Gujarat has done. Another would be for Mr Modi to build momentum over several years for a wholesale recasting of the rules, driven by the centre. Either way, it will require nothing less than a complete change of outlook for a country that has forgotten how to do business simply.
Sitting at his desk in Gujarat, Mr Modi said that when he first took charge of the state’s economy, “I thought: the sky is the limit.” A similar ambition today would serve India well.
