Demonetisation and GST have not hurt the BJP

The party moved quickly to assuage people’s angst through changes in rates and reporting requirements

Elections involving millions of voters are impossible to explain in a single overarching narrative. Such narratives are more convenient than accurate, an example of what behavioural scientists call the confirmation bias. However, elections do offer important clues about the underlying mood of citizens. The results of the Gujarat assembly elections throw light on some key economic policy challenges for the Narendra Modi government in New Delhi, in the final stretch before the next Lok Sabha elections.

The strategy that has come to be known as the Gujarat model is based on three important themes. First, marquee industrial projects with large capital investments but weak in job creation. Second, supply chains of small enterprises that have provided the jobs. Third, rapid growth in the farming sector led by irrigation as well as new technologies such as BT cotton.

Each has been under stress in recent months. The overall slowdown in corporate sector investment has not left Gujarat untouched. The twin policy shocks from demonetisation and the shift to the goods and services tax (GST) has left many small enterprises gasping for working capital. And the deflation in farm prices has put real incomes of farmers under pressure.

It is still too early to say for sure what impact the economic events of the last few months have had on the electoral fortunes of the Bharatiya Janata Party in Gujarat. The party saw its share of votes rise marginally, and it has held on to power despite a reduction in the number of seats it won. However, the final results were closer than the exit polls suggested. Stock market investors have, at least for now, taken a positive view of the election results — that the economic dislocations have not forced the BJP out of power even in a commercial society such as Gujarat indicates that Modi’s political appeal is intact.

The deflation in prices of farm produce has shifted the terms of trade against agriculture. In other words, the prices of items produced by farmers have gone up at a slower pace than the prices of the industrial goods consumed by farmers. The Modi government had managed the food economy deftly in the first half of its tenure, to bring down food inflation from the highs seen during the tenure of the second Manmohan Singh government. If the voting pattern in rural Saurashtra is any indication, however, the BJP could be under political pressure to revert course – either through a farm loan waiver or higher minimum support prices – to win back part of the farmer vote.

Gujarat is one of the most urbanised states in India. 42% of the population lives in cities as against the national average of 31%, according to the 2011 Census; so rural angst is relatively less politically potent than in the case of the more rural states. But rural Gujarat has not made progress in creating non-farm jobs. The 2011 NSSO data shows that 75% of the rural Gujarati workforce is employed in farming as against the national average of 64%. So farm distress pinches more acutely in rural Gujarat, even as the high urbanisation rate reduces its overall political impact. The calculus is quite different in other states such as Uttar Pradesh.

The second challenge is to streamline the GST, which is otherwise one of the most important reforms in recent years. There are two issues . One, the complex structure of tax rates has led to a lot of friction. Two, the onerous GST reporting requirements have put the working capital of many small enterprises under strain. Economist Indira Rajaraman has persuasively argued that the initial GST requirements put small enterprises at a disadvantage. A financial analyst in Mumbai I spoke to after the Gujarat election results were announced said that his travels through manufacturing hubs such as Surat and Morbi over the past year suggest that small enterprises were struggling with tight working capital conditions after the shift to GST. Exporters in labour-intensive industries such as textiles were also feeling the pain. Why does this matter? Urban Gujarat is more dependent on industry than services. The 2011 NSSO survey shows that share of the urban workforce in manufacturing was 39%, compared to the national average of 24%.

It tells us a lot about the responsiveness of the BJP that it moved quickly to assuage the pain through changes in GST rates as a well as reporting requirements. The Modi government – through the GST Council – now has strong political incentives to streamline GST over the next year, with fewer rates, lower rates, less onerous reporting and quicker refunds of input credits.

Modi took political risks by pushing through policies that should eventually help bring informal enterprises into the tax net, and the Gujarat results suggest that it has not hurt it politically despite the obvious economic pain in the short run, especially if the ongoing economic recovery gains momentum.