Modi finds his mojo
India, according to its many skeptics, will never change. It is too messy, too unwieldy—perhaps too democratic—to emulate China as a driver of global growth. For all the hoopla that greeted Narendra Modi’s election in 2014, little changed for the better during his first two years in charge: the new government failed to pass “big bang” reforms, banks stopped lending, and investment slumped. Critics accused Modi of being all talk and no action.
After a summer of reform, those critics must now eat their words. The Goods and Services Tax bill, passed in August, is one of the most significant pieces of legislation since Indian independence. The adoption of inflation targeting— cemented into law last month and overseen by a quasiindependent monetary policy committee—means the central bank is no longer in thrall to the government. A new bankruptcy code, passed in May, is a key step to help clean up bank balance sheets. Moves to scrap onerous foreign investment regulations have helped push India to the top of the global FDI rankings for greenfield projects, ahead of China. And, crucially, efforts to nurture a spirit of competition and enterprise among India’s 29 states are bearing fruit. It is still early days, but investors should start to take India seriously.
It is difficult to overplay the significance of the GST. By creating a unified tax system that will allow goods to move freely across states, it promises to transform India’s fragmented economy into a genuine common market. In time, this could add as much as 2pp to annual economic growth. Passing the GST bill required Modi to bring both the opposition and India’s 29 state governments on board, proving that his government has the political capital to get things done. The GST Council will meet over the next few weeks to finalize a deal that should allow GST to be operational by April.
More important for India’s immediate growth prospects are reforms to ease pressure on its struggling banks. The bankruptcy code should, in theory, enable lenders to recover funds more quickly from stalled infrastructure projects— vital, as these are the biggest source of stressed assets. Meanwhile, efforts to liberalise the bond market will help banks to meet tough capital requirements, thereby freeingup capital for loans. As banks recognize NPLs, restructure loans and repossess assets, we expect India’s stalled investment cycle to turn in the second half of next year.
Areas where the central government have so far failed to make much headway include land and labour reform. A new bill that would no longer require firms to seek central permission to lay off large numbers of workers could be presented to parliament in November, as Modi seeks to ride the momentum gained from the GST. Since vigorous protests are a certainty, it would be no surprise if it fails. But the growing power of India’s states, boosted by New Delhi’s devolution of fiscal powers to state governments, means that reform of factor markets will happen anyway. Modi is allowing states to alter, or even bend, centrally-mandated rules such that ambitious local ministers can seize the initiative.
Take labour legislation, which is the shared responsibility of both the centre and the states. Federal law requires firms with more than 100 employees to seek permission from the centre before they lay off workers. But the states of Rajasthan and Madhya Pradesh have amended their laws to push that figure up to 300 employees. And in the state of Telangana, ministers claim that restrictive national labour laws do not apply in its many special economic zones, where it has implemented a more liberal regime.
Modi is popular among the more forward-thinking state governments, even those that are not aligned with the BJP. Despite being mocked by liberal commentators for gallivanting around the world as a trumped-up travelling salesman, state-level ministers say Modi’s foreign trips have succeeded in establishing that India is open for business. The “Make in India” campaign has focused their attention on attracting foreign investment. A handful of states have long courted foreign companies—Modi’s home state of Gujarat is an obvious example—but that mindset is now spreading across the country.
Business people I spoke to in India earlier this month were upbeat. “We’ve done more business in the last 10 months than in the previous seven years,” the president of Boeing India told me. In progressive states like Telangana, which has attracted a flurry of big foreign investments over the past year, the word on the street is that 2017 will be even better. After initially struggling to live up to unrealistic expectations, Modi has finally found his mojo.