20 May 2014

India's Incoming Government Faces Challenges of Jump-Starting Economy

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Blowout Election Victory of Pro-Business Party Raises Hopes
By 
RAYMOND ZHONG
Updated May 18, 2014 11:26 p.m. ET


Thousands of Bharatiya Janata Party supporters welcomed India's next prime minister Narendra Modi to New Delhi ahead of his talks to form a new government. Photo: AP

NEW DELHI—India's incoming government will face daunting challenges to revive Asia's third-largest economy and get it on a sustainable growth track.

The blowout election victory of the pro-business Bharatiya Janata Party has raised hopes that a strong government led by Narendra Modi, its prime ministerial candidate, can jump-start commerce. According to final results released Saturday, the BJP won 282 of the 545 seats in the lower house of Parliament, allowing the party to form a government without the support of allied parties.

The Indian National Congress, in government for nearly all of the country's post-independence history, suffered its worst result, winning just 44 seats. Mr. Modi and the Hindu-nationalist BJP replaced sectarian rhetoric with promises of jobs and development, riding a wave of disgust with India's economic stagnation under the leadership of the departing Congress party-led government.

Mr. Modi met Sunday with other party leaders to discuss picking a cabinet.

"I want to assure the people of this country that we will live up to the faith you have shown in us," Mr. Modi told supporters during victory celebrations on Friday. "The lives of young people in this country won't change without development."

A blowout election win for Narendra Modi's pro-business BJP has raised hopes for jump-starting commerce. Reuters

Economic activity is expanding at almost the slowest clip in a decade, less than 5% year-over-year in the first quarter of 2014 down from more than 9% in 2011. Inflation has remained high despite the slowdown because of bottlenecks in production and infrastructure, which prevent companies from ramping up output. And job creation isn't keeping pace with population growth—a major problem in a country where 10 million people turn working-age every year.

A revival of business investment and spending would help. The BJP's pledge to streamline bureaucratic procedures would make it easier to do business in a country famous for burdensome and often capricious regulation. It could also boost exports—crucial to reduce reliance on inflows of foreign financing as the U.S. Federal Reserve cuts back on its bond purchases to stimulate the economy.

The Fed's stimulus had boosted emerging economies in Asia and elsewhere by driving investors to seek higher returns in riskier markets.

The announcement of tapering the stimulus last year triggered flows out of those markets and India was among the worst-hit.

Among other problems that need to be addressed are persistent fiscal deficits that also foster dependence on foreign capital. Government spending swelled during the 2008 global financial crisis, as Delhi raised government workers' salaries and expanded welfare programs amid other measures to stimulate the economy. Budget deficits didn't come down, however, even after the panic subsided.

Hence many economists' calls for the new government to reduce India's expansive subsidies for food, diesel fuel and fertilizer, among other things, which together account for about 15% of total spending. The new government has to present its first budget by July.

Cutting subsidies would be unpopular. Steps to increase revenue, such as privatizations, also would be politically difficult.

Mr. Modi established a record of economic success while serving as chief minister of the western state of Gujarat by making it easier for companies to set up there.

But at the national level, the sorts of big policy changes on economists' wish lists—such as privatizing rickety state-run banks or relinquishing the central government's monopoly on coal production—would be far more controversial and require bold leadership. Institutional constraints complicate Mr. Modi's task. The BJP doesn't have a majority in the upper house of Parliament, whose members are chosen by state legislatures. That means that while the new government can quickly take cabinet-level actions such as greenlighting industrial projects that are already in the pipeline but haven't been implemented, legislative changes will require broader consensus.On certain kinds of reforms, moreover, the central government can't go it alone.

Topping many companies' wish-lists for the new government is a single goods and services tax that will simplify the current web of overlapping state levies.

But the plan stalled under the previous administration partly because it requires states to surrender fiscal autonomy. Some states fear that they will lose revenue if local levies are subsumed into a single, nationwide tax.

India's next prime minister, Narendra Modi, right, talks to senior BJP member Lal Krishna Advani at Mr. Advani's residence in New Delhi on Sunday after the pro-business party won a resounding victory in elections on promises of jobs and development. Associated Press

Overhauling India's labor laws to ease hiring and firing—also high on firms' wish-lists—will likewise require cooperation with state governments. All of this suggests that Mr. Modi's ascent isn't likely to deliver an immediate kick to growth.

Some doubt the BJP, even with its sweeping electoral mandate, can overcome entrenched interests to shrink the state's role in the economy.

"A lot of Modi-boosters are jumping the gun when they wish to see a Reagan or a Thatcher in him," said Ajay Shah, an economist at the National Institute for Public Finance and Policy in New Delhi who has been critical of the economic policies pursued by the Congress party.

"The greatest challenge will be to get the states on board," said Arvind Virmani, a former executive director at the International Monetary Fund.

"The major positive [effect] is unlikely to show up in a big way for a couple of years at least," said Vidya Mahambare, an economist at the ratings firm Crisil.

Still, the BJP's thumping win on a pro-growth, pro-development platform suggests Mr. Modi has too much at stake to rest on his laurels.

"Even if [GDP growth] reaches our 6% forecast this year without the new government doing significant reforms, 6% isn't going to create the jobs that are necessary," Ms. Mahambare said. "There's no incentive for the new prime minister to relax."

—-Niharika Mandhana and Saptarishi Dutta contributed to this article.

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