Why BJP’s massive win in India’s recent state elections will not lead to big bang reforms and it may follow more populism

After a spectacular win in the recent state elections especially in India’s politically most important state, India Inc and financial press would expect Modi Government to push big bang reforms which in its opinion, are needed to take India to a double-digit growth trajectory that the Prime Minister has promised.

Will that happen? Will BJP’s election victories bring more reforms or make the government more populist in the run to 2019 general election that PM Modi seemed to have set his eyes on.

BJP’s massive win in UP and the neighboring state of Uttrakhand along with the good performances in Goa and Manipur will help it to improve its tally in the upper house of Indian Parliament, Rajya Sabha that has imposed limits on Modi government’s ability to push crucial legislative reform bills such as those related to GST or Land Acquisition in the past. Financial market analysts say things will change now for the better and that’s not without reason.

The state of UP accounts for the largest number of Rajya Sabha seats at 31 – one third of them – six SP, two BSP and one each BJP and Congress are to retire soon. With BJP (or its allies) ruling over more than half of all Indian states, it is likely to make big gains (of at least 11, taking its tally to 67 in the upper house while Congress will be down to 48 from 59) in the biennial elections for 55 Rajya Sabha seats due next April.

Despite that BJP will still be short of a clear majority in the upper house. Moreover, is having a comfortable majority in the upper house guarantee big bang reforms? The answer requires a critical look at the first 30 months of Prime Minister Narendra Modi’s tenure.

Reform push

There’s no denying that the Prime Minister is a crafty campaigner and big election winner. However, his record of delivering on economic front is not impressive: economic growth (even if one ignores the questionable GDP numbers remains below expectation.

Job creation was one of the key poll planks in 2014, but the government has failed to deliver on that. The following table provides the details of jobs added by 8 key sectors namely manufacturing, construction, trade, transport, hospitality, information technology, education and health in lakhs (1 lakh = 100000). 

Clearly not many new jobs are being added. Even in 2016, these 8 sectors could add just 77000 jobs in April-June quarter - the latest data available.

Investment as a percentage of GDP has declined from 30.3% in FY 2014-15 to 29.2% in FY 2015-16 and is likely to fall to 26.9% in FY 2016-17 according to CSO. Investment in the private sector remains a bigger worry (despite several interest rate cuts since Jan 2015) without which the promise of double-digit growth can’t be fulfilled. That calls for increased public investment but the share of capital expenditure in total government expenditure remains low as ever at 12.5% or so.

Modi’s pet infrastructure projects, mega highway projects in particular have not made much progress. Prime Minister has laid foundation stones for 11 highway projects since assuming office in May 2014. Government is to provide 100% funding for most of them — hence lack of finance can’t be a problem. Yet only 2 out of 11 are on track. Against an ambitious target of 41 km per day only 18 km of highways are being constructed per day.

Except GST and introduction of Insolvency and Bankruptcy Code (IBC), and may be, a check on big corruption, Modi government has not delivered on tougher policy reforms especially those dealing with freeing the pricing of agricultural commodities, chemical fertilizers (urea in particular) and natural gas (necessary for boosting investment), or taxing rich farmers despite there being a solid economic case for that. Electoral reforms to curb use of black money in politics are more talk than action. Not all of the above reforms require majority in the upper house of the Parliament, e.g. urea and natural gas pricing.

Despite so much hype about business facilitation, India’s rank remains a dismal 130 on World Bank’s Ease of Doing Business global ranking. Besides, most of the work on ease of doing business either done by New Delhi or the states – are though positive but mostly procedural simplification (to make it easier for businesses to comply) rather than substantive game changing policy reforms. For instance, it’s now easier to file labor compliance reports than say three years ago. So, it’s a progress no doubt but multiplicities of labor laws (that are often over-lapping and open to interpretation) still exist and add to the cost of doing business. The same applies to tax regulations. That discourages investment especially by new or first time entrepreneurs and SMEs.

Border procedures are now less cumbersome than they used to be but however smoothened they are, that can’t substitute the need for addressing what’s called inverted duties (i.e. high duties on raw materials and lower duties on finished products) that discourage value addition and job-creation in the key manufacturing sub-sectors such as chemicals, electronics and textiles. Again, the procedural simplification can’t really compensate for poor transport and logistics infrastructure.

During 10 years of the UPA rule (2004-14), FDI as a proportional of India's GDP averaged 1.86%. In the last three years of the PM Modi's tenure (2014-17), it averaged 1.83% - not much difference. Secondly, most of the FDI inflows are coming through private equity or merger and acquisitions route - that does not create new assets or jobs because it’s still very difficult to push green field projects. Moreover, India’s FDI policies often come with irritating riders that don’t make sense - sourcing restrictions in retail or unnecessary distinction between market place, or inventory based online retailing for instance.  

The government provide incentives (both negative as well positive) for companies to remain small such as exemption from complicated labor regulations or preference in government procurement that induce Indian firms to remain small and escape benefiting from the economies of scale. Yet, instead of removing such policies, Modi government has added a few of its own to the list e.g. lower corporate tax for firms with an annual turnover of 500 million rupees or below for instance.

Will that change after the UP results?

Many optimists think that with landslide victory in UP and other states, PM Modi will become bolder in pursuing crucial reforms related to land and labor markets, or resolving the twin balance sheet problems of indebted firms and state owned banks to support investment and growth. They may be disappointed.

The simple reason is: PM Modi appears to be wary of any bold pro-business reform action that can be portrayed as anti-poor and a sell-out to corporate lobby by the opposition. Such reactions in the past led the Prime Minister to backtrack on land bill and having a consensus approach on GST even if that meant having a sub-standard GST that will reduce its beneficial impact. If we look at Modi government’s last two Union budgets, a clear focus on rural India (than pro-business reforms) is evident.

If the last two and a half years of Modi’s tenure are anything to go by bolder reforms are not happening, more so after PM Modi’s new avatar as the messiah of the poor that seems to be working well for winning electoral battles. With PM Modi focused on 2019, he will not be comfortable with any dilution to his pro-poor image.

Thus, no big bang reforms should be expected. The privatization of Air India, or creation of bad bank which would be interpreted as something like bailing out corporate defaulters are not happening any time soon at least before the next general election.

Instead, the promised loan waiver and interest-free loans to farmers in UP will further pressurize the financials of India’s banking system already troubled by high and rising bad loans. UP farmers owe 860 billion rupees to public sector banks. Any action on loan waiver in the state means the farmers would postpone repaying loans expecting future waive offs. Worse, that may induce similar demand in other Indian states especially those going to poll in near term such as Karnataka.

To sum up, seeing that dole outs and freebies are helpful in winning elections, Modi government is likely to be more populist than reformist going forward.

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A modified version of this post that I co-authored with Prerna Sharma catering to International readership has been published in Nikkei Asian Review from Nikkei-Financial Times Group: Election victories no guarantee of reform from India's Modi