India's Economy in Flux 

Salman Soz

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In the 2014 parliamentary elections, Prime Minister Narendra Modi and his Bharatiya Janata Party (BJP) won a decisive victory. For the first time in almost three decades, India’s Prime Minister would lead without the pressures of coalition politics. PM Modi’s reputation as a hard charging, pro-business leader, and his masterful election campaign, which was aspirational and populist in equal measure, raised hopes for radical change, reforms, and better prospects for India, a country that remains poor despite progress in recent decades. Limited government, economic transformation, and job creation were at the center of PM Modi’s campaign. Three years have elapsed since PM Modi took office. While three years is insufficient time in which to assess the full impact of a government’s economic policies, it does provide an opportunity to undertake a mid-term review.

This paper assesses PM Modi’s economic policies, reviews India’s progress along key economic indicators, and identifies overarching issues that challenge India’s future economic growth trajectory. Some of the questions posed in this paper relate to the policy framework adopted by PM Modi’s government and the extent to which it departs significantly from the policies of the previous government. We also review PM Modi’s election campaign promises and how far his government has succeeded in delivering on those promises. Is the economy transforming and creating jobs? Are investments picking up and is the banking sector recovering from its burden of non-performing assets (NPAs)? How is India’s rural economy faring? These and other questions are the focus of this report.

This paper’s overall assessment is that apart from some notable exceptions, PM Modi has chosen to follow an incremental approach as opposed to radical economic reform. Economic growth is high on the agenda, while social transfers through schemes such as the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS) remain in place. The government has also continued on the fiscal consolidation path that the previous government had embarked on. Inflation has dropped significantly, in part because of a sharp drop in crude oil prices. After two successive droughts in 2014 and 2015, the rural economy rebounded last year. Foreign direct investment has risen steadily during PM Modi’s tenure and he has promoted India as a destination of choice for foreign investors. However, domestic private sector investment is weak and has dragged the overall investment ratio down in each of the last three years. Private investment woes are linked to serious problems in the banking sector, which is bogged down by substantial and growing non-performing assets. While India has grown faster than China for much of the past year, this has not resulted in the type of job growth that India needs. In fact, formal sector job creation is weaker than in previous years and will pose a major challenge for policymakers in the years ahead.

            The Prime Minister has left his imprint on policymaking and policy implementation. Some of PM Modi’s policies are bold departures from the norm. However, the judiciousness of such bold moves remains a subject of debate. One of the early initiatives of the government was to roll back the 2013 law on land acquisition. The 2013 law received support from PM Modi’s party even as there were apprehensions among business groups that the new legislation could make land acquisition more difficult. Land acquisition is a fraught topic in India, as it is in many developing countries. Perhaps PM Modi felt that his electoral victory provided him with political capital to expend on reversing the law. While PM Modi initially persisted with his efforts despite expected opposition, after critical viewpoints strengthened he abandoned his campaign.

Another initiative that PM Modi has invested considerable effort in is ‘Make in India’, a program to help revive manufacturing and to create much needed jobs. PM Modi has set ambitious targets such as growing manufacturing contribution to 25 percent of GDP by 2022 and creating 100 million manufacturing jobs. While the previous government had similar targets, they were set over a longer period of time. In some respects, PM Modi is trying to replicate the success of China and other Asian nations. However, economic conditions are now different compared to the time when Asian countries used manufacturing and trade to grow and to create jobs. With protectionist sentiment rising in some countries and automation threatening manufacturing jobs, PM Modi’s ‘Make in India’ faces considerable headwinds.

PM Modi pushed through a major tax reform widely seen as promoting economic growth. The Goods and Services Tax (GST) tries to streamline India’s complicated indirect tax system. Initially promoted by the previous government, the GST was opposed by various states, including Gujarat, where PM Modi was then Chief Minister. However, with a more favorable arithmetic in state legislatures and broad national consensus on GST, PM Modi steered this reform through Parliament. Individual states are in the process of ratifying it. Implementing this complex reform will no doubt be challenging, but once the kinks are worked out, the GST could add to India’s economic growth and make the tax system less onerous.

The most controversial of PM Modi’s initiatives was last year’s decision to withdraw high denomination banknotes from circulation. In November 2016, PM Modi made a surprise announcement, withdrawing Rs. 1000 and Rs. 500 banknotes with the aim of targeting illicit wealth generated through cash transactions. This “black money”, as illicit wealth is called in India, accounts for upwards of 20 percent of India’s GDP. The government believed that some of that money was held in cash. By withdrawing high denomination notes, which accounted for 86 percent of the value of cash in circulation, PM Modi hoped to force illicit wealth holders to either not exchange their cash for new banknotes or declare their illicit wealth and pay high taxes and penalties. Demonetization, the popular term for the currency swap, remains hugely controversial. Many economists were critics of the policy and accused the government of imposing it without thinking through all the consequences. One of the biggest problems with demonetization was that holders of old banknotes were not able to quickly and conveniently exchange their money for new notes. This resulted in economic disruptions, especially in the cash-dependent informal sector, which accounts for about 40 percent of India’s GDP and over 80 percent of its employment. Demonetization remains hotly debated, but recent economic data released by the government’s Central Statistical Office (CSO) indicates that the policy had an adverse impact on economic growth.

The Indian economy faces significant challenges in the medium-term. The banking sector remains weak due to high NPAs, credit growth has stalled and private sector investment has not picked up, despite PM Modi’s efforts to fast-track project implementation. While the government pushed hard with ‘Make in India’ and demonetization, similar urgency was not evident in dealing with the problems of the banking sector. If the economy underperforms, the lack of resolution of problems in the banking sector could be a key cause. In the remainder of his term, PM Modi must focus his energies on resolving the NPA crisis and helping restart the private investment cycle. Beyond these challenges is the looming demographic shift that requires the creation of almost one million jobs each month. Many young people hope to move out of low productivity jobs in agriculture, so manufacturing and services will have to produce more jobs. To accommodate the rural-urban transition, urban services need strengthening. But, a less than benign global economic environment makes PM Modi’s task harder. Furthermore, technological improvements and automation make job creation potential in manufacturing uncertain. PM Modi has his task cut out for the remainder of his term.