30 May 2019

Five Challenges Facing India's Reelected Government

The world's largest democratic contest has drawn to a close, and the verdict is clear: Narendra Modi has secured another five-year term as India's prime minister. The 68-year-old incumbent led his Bharatiya Janata Party to a victory on May 23, deftly maneuvering his way around the opposition's slings and arrows led by the Indian National Congress.

The Big Picture

As the dust settles following his landslide victory, Indian Prime Minister Narendra Modi will now have to reckon with resolving the myriad of internal and external challenges that continue to hinder India's progress. High unemployment and a cooling economy, as well as looming trade concerns and China's encroachment into South Asia, will be of chief concern for Modi's administration in the coming years, as he attempts to bring the country's burgeoning military and economic power in Asia to a head.

Modi will retake his place at India's helm at a pivotal moment in the country's history, as New Delhi manages its rising economic and military stature alongside an array of challenges in its economy, trade negotiations and foreign relationships. How Modi's government resolves the following key issues in the next five years will determine the extent to which India can capitalize on its enormous population and economy to produce more jobs, raise the standard of living and have an overall stronger presence on the global stage. 

1. The Shadow Banking Crisis

The Challenge: India's nonbanking financing companies, known as "shadow banks," have faced a cash shortage ever since a shadow bank named Infrastructure Leasing & Financial Services (IL&FS) — one of the nation's key infrastructure lenders — defaulted on its debt payments in September. The default triggered panic among mutual funds and banks, which have since grown reluctant to offer shadow banks more money. Shadow banks are an important component of India's financial system, and any challenges to their ability to offer credit will further drag on India's private sector investments and hurt consumer purchasing power.

The Opportunity: To help stave off a contagion, the Reserve Bank of India (RBI) — which is now under the leadership of Modi's new appointee, Shaktikanta Das — recently announced plans to pump $3.6 billion back into the economy. The RBI has also called on shadow banks that own at least $717 million in assets to appoint a risk officer before it will offer them more credit.
2. Unemployment

The Challenge: Unemployment continues to plague India's economic growth. In February, Modi's administration refused to release a labor report that was rumored to contain data suggesting unemployment had reached 6.1 percent, a 45-year high. However, nongovernment data estimates India's private sector employment grew 1.3 percent over the course of the BJP's first term — a considerable slowdown from the 6.5 percent growth in employment during the Indian National Congress' previous term (2009-2014).

How Modi uses his next term will determine the extent to which India can capitalize on its enormous potential to produce more jobs, raise the standard of living and have an overall stronger global presence.

The Opportunity: In the short term, Modi's government will focus on addressing unemployment through various welfare programs. This includes making good on a program announced in February to offer an $84 annual stipend for up to 120 million farmers, as well as advancing the Mahatma Gandhi National Rural Employment Guarantee Act, which guarantees 100 days of paid manual labor to adults in rural households. But these are temporary fixes to a much deeper problem rooted in India's outdated land and labor laws. Thus, in the long term, Modi's government will also pursue structural reforms to these laws to advance the country's lagging industrialization and, in turn, churn out more manufacturing jobs.

3. Economic Growth

The Challenge: India's $2.6 trillion economy is the sixth largest in the world, and remains one of the world's fastest-growing economies for its size. During the past five years under Modi, annual growth peaked at 8.2 percent in the fiscal year of 2016-2017. However, growth has continued to drop since then and is now projected to fall to 7 percent in the country's fourth-quarter economic data once it's released May 31.

India's latest GDP figures (released May 1) point to dips in the growth of consumption, fixed investment and exports. And that's a problem for India, since it relies heavily on private consumption to fuel its economy. Thus any slowdown in consumption without a positive shift in other potential economic drivers — such as government spending, private investment or net exports — will continue to put the breaks on its economy as a while.

The Opportunity: To bring its economy back up to speed, an ongoing priority for Modi's government will involve spurring greater private sector investment in India. This could include resolving nonperforming assets, which account for roughly 10 percent of all loans from state-owned and private banks in India.
4. Trade Negotiations 

The Challenge: The United States remains one of India's key defense partners, though the two have sparred over trade in recent months. In April, U.S. President Donald Trump revoked New Delhi's tariff benefits under a U.S. program that was put in place the 1970s to boost Washington's trade with developing countries. In retaliation, New Delhi has repeatedly threatened to impose $235 million worth of tariffs against the United States. Elsewhere, India's new government will need to address India's position in the Regional Comprehensive Economic Partnership (RCEP), a pending free trade agreement between the Association of Southeast Asian Nations and its six free trade partners — India, China, New Zealand, South Korea, Australia and Japan. Compared with the others, however, New Delhi remains the biggest skeptic of the RCEP — wary that it will add to its trade deficit with China.

The Opportunity: India sees the United States as a vital export market, and will thus seek to avoid an escalation unless Washington launches another salvo — explaining why New Delhi has continued to delay imposing its retaliatory tariffs. When it comes to the RCEP negotiations, Modi's administration will continue to push for a trade package in which it secures concessions for India's robust IT services sector in exchange for a phased tariff liberalization on manufacturing goods. 
5. China's Encroachment 

The Challenge: India's relations with China have been relatively calm following the 2017 standoff in Doklam, when thousands of Indian and Chinese troops nearly came to blows over disputed territory between Bhutan and China. However, India still views China as its principal strategic rival. New Delhi is particularly concerned over Beijing's expansion into South Asia through its Belt and Road Initiative which counts five of India's neighbors as signatories — Pakistan, Bangladesh, Sri Lanka, the Maldives and Nepal. By funding infrastructure projects, expanding military ties and cultivating political clout in these countries, Beijing is fueling New Delhi's long-term fears of being encircled by Chinese influence.

As both countries expand their military presence along their vast Himalayan frontier, the competition over the buffer states of Nepal and Bhutan will also heighten in the coming years. And as New Delhi's reliance on Indian Ocean trade grows, so too will its desire to forge resilient relations with the region's island nations, including Sri Lanka and the Maldives, and loosen them out from China's grasp.

The Opportunity: To ward off China's growing threat to India's regional heft, Modi will buckle down on his "Neighborhood First" policy by bolstering diplomatic contacts with the South Asian countries involved in China's Belt and Road Initiative (that is, except for its arch nemesis Pakistan). This will also include showering its neighbors with more foreign aid, in an effort to offset that of Beijing's.
Shaping the Arc of India's Ascent 

Having spent the past five years in office, Modi is well-versed in the nuances of these economic and political challenges that continue to hold India back from materializing its potential as the world's sixth-largest economy and the second-largest population. Therefore, what Modi does with his next term — and whether he uses that experience to now follow through on the sweeping reforms promised on the campaign trail — will shape the arc of India's ascent in the coming years.

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