Overview

The election in May 2014 of a new government in India raised expectations around the world of the likelihood of far-reaching changes in India’s economic and foreign policy orientation. The new Prime Minister, Narendra Modi, had performed effectively as the Chief Minister of Gujarat State. His party, the Hindu nationalist Bharatiya Janata Party (BJP), also asserts its business-friendly credentials. India was, for the first time in its history, being led by a conservative government with a clear parliamentary majority and a Prime Minister with prior governance experience.

Before his election as Prime Minister, Modi successfully diminished concerns about the religio-cultural conservatism of his party. He was expected to bring a breath of fresh air to the stale, old style of Delhi politics. Economic reform and alliance with the West were important planks of Modi’s election platform. Modi was expected to be a catalyst for India’s economic growth, removing the shackles of over-regulation quickly. One year later, it seems that caution characterizes the Modi government’s performance just as enthusiasm had defined Modi’s election promises.

India’s economy is growing but not because of government policies and actions. The pace of growth has increased because of global economic factors, such as lower oil prices, and the fact that the market still ‘hopes’ that things will change. Some government actions, such as ‘tax terrorism’—imposition of retroactive taxes on multinational corporations—and the lack of implementation of tax and labor reforms, have hurt India’s economic outlook.

Why is it that an administration that was elected to power to bring about change has not been able to do so? Admittedly, it is difficult to overhaul an economy the size of India’s within twelve months. But by now, the Modi government could have laid the foundations upon which it plans to build the edifice of a modern, prosperous, free market oriented India.  

Modi is the first Prime Minister since the election of Rajiv Gandhi in 1985 to receive a massive electoral mandate. Unlike governments from 1990 to 2014, which depended on coalitions in parliament, Modi’s BJP won a clear majority of 282 out of 544 seats in parliament. With smaller parties allied to the BJP, the government’s strength in the Lok Sabha (Lower House of Indian Parliament) stands at 300, a comfortable number to ensure legislation and approval of fiscal measures.

The Modi government is not hobbled by the sense of policy paralysis that existed under the United Progressive Alliance (UPA) coalition led by the Congress Party’s Manmohan Singh. Still, things have not moved forward during Modi’s first year in office, creating frustration amongst those who voted for and supported the BJP’s election.

The flagship program of the Modi government, ‘Make in India,’ is only the latest version of India’s historic pursuit of economic and military self-sufficiency. The scheme encourages foreign companies to invest money and technology to expand manufacturing within India. Investors, however, would like to see reforms in bureaucratic regulations, tax policy, land ownership rules and labor laws before committing to major projects.  

During the election campaign, Modi supporters argued that as an outsider in Delhi, the prime minister would cut India’s penchant for bureaucratic red tape. In its first year, the Modi government failed to live up to that expectation. Instead it appears to rely heavily on the bureaucracy for policy guidance, rather than demanding that civil servants give effect to the political leaders’ ideas. For example, Modi described retroactive taxation on multinational corporations as a ‘breach of faith’ during his election campaign. Instead of changing the tax laws that make such ‘breach of faith’ possible, the government opted for the tax bureaucracy’s proposed way out by saying that they will choose not to apply these laws.

Such compromises are insufficient to reassure international investors who do not want to deal with retroactive tax demands in future. There is similar uncertainty in relation to the acquisition and ownership of land, which is important to corporations and foreign investors. The law on land acquisition is currently an ordinance (approved by the President for six months till the time that Parliament passes it) instead of an Act of parliament because of opposition within the BJP and its parliamentary allies.

An understanding of the internal divisions within the BJP may help explain some of the problems facing Modi. The core of the BJP is comprised of those who rose up the ranks in BJP’s ideological mentor organization the Hindu chauvinist, Rashtriya Swayamsevak Sangh (RSS, National Volunteer Corps). Similar in outlook to RSS members are those BJP politicians who belong to and sympathize with the Swadeshi Jagran Manch (Forum for Raising the Nation’s Consciousness). Both these groups support Indian business but oppose foreign investment and maintain a somewhat xenophobic stance.

These ultra-nationalists oppose the entry into India of multi-brand retail stores like Walmart or Carrefour on grounds that these retail giants will wipe out India’s small mom and pop stores. ‘Make in India’ appeals to these xenophobes not just because it contributes to Indian autarky but because it keeps the foreigners out.

Modi had also promised to focus on India’s military modernization, recognizing that India had failed to build a world-class domestic defense industry in 60 years. So far, Modi has not effectively tackled the reasons for this failure though the government continues to promise significant changes to India’s defense procurement and production processes. Heavy dependence in defense industry on the public sector, keeping out private players and thus removing competition, a system that dis-incentivizes innovation, and lack of access to latest foreign technologies coupled with lack of foreign investment remain key issues in this field.

Compared to other developing economies, India is the lowest spender on Research & Development (R&D). The Indian government continues to be the largest R&D investor with the corporate sector and academia investing a negligible amount. In order for Indian and foreign corporates to invest, India needs to create incentives for innovation in addition to providing a regulatory framework that encourages companies to share their technology. India needs to spend more on R&D and to incentivize innovation for higher growth rates. One year may be too short a period to measure success in this sphere but the Modi government has, so far, not initiated policy changes that would enable us to determine that research, development and innovation are among its priorities.

Nowhere is the lack of new think about R&D and innovation more visible than in the pharmaceutical industry. The Indian pharmaceutical sector, like the software industry, is a source of pride for Indians. India’s domestic pharmaceutical industry has performed a dual function: provision of cheap drugs domestically and supply of these drugs to other developing countries. The latter helps India fulfill its desire to be seen as an example to other nations. Indians are proud that locally made drugs are available in South Africa and Brazil. But that does not mean that Indian pharmaceuticals are at the cutting edge of technology.   

Lack of regulations and accountability as well as competition from foreign drug companies sets back India’s pharmaceuticals. Recent reports by the US Food and Drug Administration (FDA) demonstrate that many Indian companies do not maintain international quality standards. India has so far passed up opportunities for investment in R&D and access to new technologies that could come with collaboration with foreign companies. In its first year, the Modi government has not taken steps that would reassure about the future in this area.

The government’s decision to reduce education spending and the federal healthcare budget reflect ill preparedness for dealing with demographic changes. India will soon become the most populous country in the world, overtaking China by 2028. India has the advantage of a demographic dividend: it will continue to have a low dependency ratio and a large working age population. In order to take advantage of this dividend India needs to invest in education, skill development, and provision of basic amenities like healthcare, energy, clean water and sanitation.

Like ‘Make in India,’ the Modi government has focused on describing policies in short slogans. Modi has initiated the drive for a ‘Clean India’ and has championed ‘International Yoga Day.’ While these programs are well intentioned, they are not a substitute for sound policy decisions. It might take decades to create a civic culture that emphasizes cleanliness both at home and outside. The government needs to devise schemes for provision of clean water and improved sanitation rather than just emphasizing citizens’ responsibility in maintaining cleanliness. Simple living and high thinking are great ideals for an individual, but a government needs to be pragmatic.

The BJP-led government was voted into power by a new generation of Indians. The new Indian electorate is aspirational and demands instant gratification and immediate results. Modi’s other backer, domestic and foreign business, is also impatient for positive results.    Markets run on sentiments and until now the upswing in Indian economic growth has been primarily because the markets remain hopeful of change for the better. Prime Minister Modi must act fast before this hopefulness dissipates.


The Modi government should not assume that it has a generational mandate and that it could get through its first five years by implementing minor policy changes while waiting for re-election in 2019 before undertaking major reforms. The previous National Democratic Alliance government led by a BJP prime minister lasted only one term because of its timid approach to policy change; Manmohan Singh’s UPA government won two terms but suffered from policy paralysis as soon as it won elections. Given his mandate and his record, Modi must prove himself different. The next four years of his government should be far bolder than the first year that we are reviewing in this report.