What the likely next Prime Minister needs to get done is obvious, but whether he can press quickly on reform is not
Narendra Modi is set to win himself what may be the toughest job in the world. A coalition led by the Bharatiya Janata Party (BJP) is about to be declared the victor in India’s latest general election, and Modi, the controversial chief minister of the state of Gujarat, will almost certainly become the nation’s next Prime Minister. His mission: To revive one of the world’s most promising emerging economies. Can he do it?
Hopes are running in the stratosphere. After years of almost nonexistent economic reform under the outgoing, paralyzed Congress-led coalition government, business leaders are itching for change, and fully expect Modi to deliver. During his tenure in Gujarat, Modi earned a reputation as one of the nation’s most aggressive economic change-agents, streamlining the notoriously obstructive bureaucracy and making much-needed improvements in infrastructure. Now there is great anticipation that Modi will do the same on a national scale. The stock market in Mumbai and the value of India’s currency, the rupee, soared on the news of the BJP victory.
Modi will take over an economy badly in need of change. Growth in the last fiscal year is expected to clock in under 5% — well below the 8%-9% pace enjoyed only a few years ago. Such sluggish growth just won’t cut it if India intends to lift the incomes of its 1.1 billion, still generally poor people.
What Modi will have to do is no secret. More than two decades after Manmohan Singh (now the outgoing prime minister) began dismantling the web of controls on private enterprise known as the License Raj, the bureaucracy has struck back. The deregulation never went far enough, and that has allowed India’s meddlesome civil servants to impede the progress of critical investments. Many large-scale projects have stalled, while new ones have almost evaporated. Businessmen struggle to acquire land and get environmental approvals and other permits.
The World Bank ranks India a miserable 134th out of 189 countries on its ease of doing business index, which measures the difficulties faced starting a company, dealing with construction permits and other factors behind competitors like China or Indonesia. Without a boost to investment, the economy will continue to stagger. That means Modi will have to strip out red tape and streamline bureaucratic procedures to make it less burdensome for companies to invest and create jobs. On top of that, Modi will have to speed along improvements in the country’s strained infrastructure — from roads to ports to power — to bring down the costs and enhancing the efficiency of doing business.
Modi must also improve India’s competitiveness in labor-intensive manufacturing. With its large, young population and low wages, India could easily be attracting more the kind of textile and electronics factories that helped alleviate poverty and supercharge exports in China.
But that’s not happening. To change that, Modi will have to tackle the sensitive topic of labor market reform. Right now, complex regulations make it too difficult and costly to hire and fire workers, and that scares away factories and acts as a disincentive for businessmen to expand their operations. If Modi makes the laws more flexible and less confusing, the benefits could be huge. Goldman Sachs, in a March report, figured that if India undertook a thorough overhaul of its labor laws, 110 million desperately needed new jobs could be created over 10 years, adding some 1.2 percentage points onto annual GDP growth.
Can Modi deliver where his predecessor failed? The good news is that it appears his BJP might have won an outright majority in the lower house of parliament, which would allow Modi to form a more stable administration than the fractured coalitions that have stymied reforms for years.
“The new government will without a doubt be in a stronger position to push through reforms than anyone had thought likely,” commented economists Mark Williams and Miguel Chanco at research firm Capital Economics. The bad news is that, in India’s federal system, Modi will also require the cooperation of state governments, most of which the BJP does not control. He’ll also have to fight it out with powerful special interest groups, like unions, that will likely resist changes to labor laws and other market-friendly reforms.
The bigger problem may be the very hopes Modi has raised. Reviving an economy of the size and complexity of India, amid its often conflict-ridden political system, cannot happen overnight. The impact of many reforms, once introduced, will take years to register their full effect. “Modi does not have a magic wand to turn around the economic fortunes of the country,” warned Societe Generale economist Kunal Kumar Kundu. Great expectations can also be a great burden.