Reboot, not reform, is the pivotal economic challenge

When the Bharatiya Janata Party (BJP) swept the 2014 general elections under Narendra Modi’s leadership, many commentators, both in India and outside, expected Modi to be India’s, Ronald Reagan. He was expected to press hard on the throttle for economic reforms, which it was argued were stuck because of the socialist camp in the Congress. Those who made such comments, especially within India, were at best being naive. The reason India did not embrace fullscale reforms or deregulation, was not just the ideological dogma of a handful of politicians. As the Modi government would learn at least twice during its tenure – the repeal of the land acquisition amendment in 2015 and the three farm laws in 2021 – pushing the envelope of reforms also creates a huge risk of political backlash. To be sure, these political roadblocks and the retreat the government has had to beat on these issues have not meant a complete abdication of the reform agenda. Among the most crucial of the reform wishlist items, the disinvestment of public sector banks in India will perhaps see another push in the forthcoming session of the parliament.

However, what has changed in the eight years of Narendra Modi and his government have spent in power, is that reform, or lack of it, is not the central parameter on which this government is being judged anymore. The biggest economic question facing this government is whether or not it can reboot the Indian economy which was battling a severe slowdown before the pandemic – revised GDP growth rate figures show that India’s growth rate had fallen to as low as 3.7% in 2019-20 – then faced its biggest ever contraction during the pandemic and is curas rently seeing a K-shaped recovery – the well-off are doing well whereas the poor, both households and firms, are still struggling to stay afloat. The fact that this challenge has come at a time when the global economy is having to navigate a geopolitical shock in commodity prices has clearly not helped.

Can Narendra Modi and his government deliver on this challenge? Can they manage a successful reboot of the Indian economy before the 2024 general elections? While there is more than enough evidence to show that the BJP under Modi has managed to buck economic headwinds to its political fortunes, there can be little doubt that both the government and the BJP would like to revive the economy as soon as they can. In fact, puling India out of the “fragile five” club after assuming office in 2014 and making it the fastest-growing economy has been one of the biggest talking points of both the Prime Minister and his party since 2014.

Here are three things which will matter in this pursuit.

The external environment, going forward, is likely to be very different from 2014

This is not just about the spike in crude oil – which even RBI now expects will continue to trade above $100 per barrel – and other commodity prices. Among the most important impacts of the pandemic in the medium term is going to be the roll-back of low, almost zero, interest rate regimes in the advanced countries, the ground for which has been created by the fiscal stimuli which was rolled out in these economies to protect incomes during the pandemic. When interest rates go up in advanced countries, foreign capital, especially of the financial variety, which is invested in the Global South is always tempted to go back. Financial inflows of this kind are an important variable in the external account stability calculus of a country such as India. While it is premature, perhaps even outlandish, to talk of an imminent external account problem or even a repeat of the “taper tantrum” moment of 2013 for India, what is also a fact is that the elbow room available on the external economic front is only going to get smaller in the medium term. The end of the easy money policy will also have implications for other tailwinds the Indian economy has enjoyed such bullish stock markets and a glut of venture capital funding for startups.

Goodbye twin balance sheet problem, hello 2-sector worry

If there is one thing which bodes very well for India’s economic prospects in the medium term it is the state of balance sheets on the side of both creditors and debtors. This is a welcome change from the largely inherited twin-balance sheet crisis in the early years of the Modi government when credit demand and supply (and hence future investment and growth) were impaired by stalled/busted projects on the corporate side and depleted capital adequacy on the side of banks. While most of the Indian corporate sector has actually deleveraged (reduced debt) in the post-pandemic period, the data so far rules out any significant build-up in bad loans on bank books. The easy money policy is bound to have helped.

To be sure, the economic headwinds facing investment could have changed its nature. Many economists have been arguing that there might be a class aspect to the post-pandemic financial health of firms in the Indian economy, where the really big ones have actually grown at the cost of the proverbial small fish. Because a lot of employment is still concentrated at the level of small firms, this is bound to generate headwinds from the demand side for the larger macroeconomy. How exactly the formal-informal sector binary plays out will be a crucial factor to watch out for going forward. How this contradiction is resolved ultimately will also determine whether or not initiatives such as Production Linked Incentive programmes can trigger the manufacturing revolution in India.

Expect the ‘terms of trade’ fault line to deepen going forward

One of the biggest demands of the farmers’ protests which erupted against the three farm laws in 2020 was that the government provide guaranteed minimum support prices (MSP) for all crops. The demand was rightfully described as impractical. Impracticality or inconsistency, however, is not the sole preserve of farmers in India’s political economy landscape on agriculture. After the Russia-ukraine war sent global wheat prices soaring, the government saw a sharp fall in wheat procurement as farmers were getting better returns in private markets both domestic and foreign. However, this time it is the government which is asking that farmers sell to the state rather than private markets. A ban on wheat exports (this has been followed by a cap on sugar exports) and a subsequent extension of the wheat procurement window, and allowing large imports of other staples such as edible oils are among the inflation management steps the government has adopted.

Farmers have been facing a sharp jump in input prices and have also been deprived of what could have been a windfall gain – to be sure, wheat farmers are also facing yield losses because of premature heatwaves – to compensate for what are normally tepid cultivation earnings. The government’s situation on this front, frankly speaking, is unenviable. It must keep inflation in check and food items are a very important part of total spending for a large number of households. But to do this via a squeeze on farmers’ incomes is a double whammy. Not only does it trigger a political backlash, but it also generates headwinds for overall growth from the side of rural demand.

Given the ups and downs of the last eight years of economic policy, and external factors that impacted it, how the government handles each of the contradictions discussed above will be crucial in shaping India’s economic trajectory going forward.