India’s New Government Messiah

Winning

To the unrestrained delight of investors and financial markets, Narendra Modi has prevailed in the audition for India’s newest Messiah.

The incumbent has been received rapturously, with commentators running out of superlatives and comparisons – Thatcher, Reagan and several Indian gods. Indian stocks, up over one-third since September 2013, and the rupee, up about 15 per cent over the same period, have a lot of good news built in to the price.

The conservative Bharatiya Janata Party’s (“BJP”) convincing victory saw it gain a rare majority in its own right, winning 282 out of 543 seats in the lower house (the Lok Shoba). In conjunction with its allies, the BJP will control around 333 seats (61% of the legislature), an unprecedentedly comfortable majority in India’s generally fractious coalition politics.

The win was based on appeals to Hindu chauvinism and the young, increasingly urban classes (India’s ‘selfies’). The electorate was tired of corruption, lack of progress, incompetent leadership and resistant to the perpetuation of the Nehru/ Gandhi “sexually transmitted democracy” (a phrase coined by writer William Dalrymple). A tired, ineffective and dysfunctional Congress led government had conceded defeat a long time ago, unwilling to waste political capital in what they saw as a lost battle.

But governing will prove more difficult than winning power. Meeting the weight of popular expectations may prove impossible.

Governing

First, the new government’s policies remain vague.

Knowing the election was theirs to lose, the BJP did not release its manifesto until late in the campaign. Devoid of detail, it promised greater growth and prosperity, elimination of corruption and removal of business red-tape. In a concerted effort to avoid leaving anybody out, it promised assistance to women, rural citizens, disabled and the disadvantaged. It promised a ‘Rurban’ strategy to supply “urban amenities to…rural areas, while retaining the soul of the village.”

Policy programs contain internal contradictions. There is a promise to reduce the budget deficit while maintaining current government spending, eschewing the difficult task of restructuring of large government programs for rural employment and food security. The BJP favours foreign capital but will protect India’s millions of small grocery shops and traders, disallowing direct investment in the retail sector, approved by the previous government.

The manifesto contained a four-page preface by BJP veteran Murli Manohar Joshi, known for his campaign to Indianize school education and enthusiasm for subjects such as Vedic astrology. It has a colourful view of history where “India was a land of abundance, prosperity, affluence, a land of sharing and caring living in perfect harmony and peace with the nature” until the “Britishers” and the Congress Party overran and ruined the country. The BJP proposes to “reconstruct the political and economic institutions of India as a continuum of civilizational consciousness” to “reorient the polity in consonance with those strong points of Indian psyche which will be the engine for our future glory.” The prolix pronouncements were reminiscent of communist politburo communications from years gone by.

Second, the new government’s room for manoeuvre is constrained by India’s current economic realities. Growth has fallen to below 5%, down from double digits. Consumption is weak.  Business investment is 9% of Gross Domestic Products (“GDP”), down from 17%. Major Indian businesses have chosen to expand internationally, rather than domestically.

Industrial output is stagnant with key sectors such as automobile sales weak. The agricultural sector which has benefitted from good rainfall, strong production and high prices is slowing.

India needs to create around 1 million new jobs each month just to absorb new entrants to the workforce. This does not take into account reducing unemployment and under employment or providing work for people migrating from rural areas to cities.

The lack of a substantial manufacturing sector constrains much needed job creation. India’s National Manufacturing policy sought to increase manufacturing’s share of GDP to 25% from 16% and create 100 million jobs within the next decade. In fact, India has de-industrialised with manufacturing declining to 15% of GDP. In the last decade, employment in manufacturing and the large agriculture sector has decreased.

Export demand has picked up, in part, due to increased competitiveness following the significant devaluation of the Indian Rupee but remains fragile due to continued weakness in major trading partners.

The current account deficit has narrowed, mainly due to lower imports driven by, in part, the previous government’s restrictions on gold imports. But the capital account remains vulnerable with weak capital inflows which are flattered by expensive bank deposits from non-resident Indians.

Policy options are also limited. The budget deficit remains at 4.6% (even after a liberal accounting) restricting the ability to initiate a major fiscal stimulus package. In reality, once state governments are included the real budget deficit is closer to 8-10%. The fact that the government has not run a surplus since independence in 1947 and under 5% of the population pays tax make it difficult to restore India’s public finances.

With continued pressure on food and energy prices, monetary policy remains focused on combating inflation with limited scope to lower interest rates to stimulate activity.

Third, the banking system remains under pressure, constraining the supply of credit. Unresolved bad debts may require recapitalisation of state owned banks, increasing budgetary problems. The combination of a weak financial system and many highly leveraged infrastructure firms means that raising funds for essential projects will remain difficult.

Fourth, India faces key external risks over which it has little control, including potential rises in energy prices driven for example by problems in Ukraine and the Middle-East, capital outflows resulting from further reductions in the US Federal Reserve Bank purchases of government bonds or a ratings downgrade. Investors have forgotten that in 2013 when the US Fed Chairman raised the possibility of a reduction in bond purchase, Indian financial markets came under sustained pressure.

Fifth, the structural change agenda remains daunting. Key areas requiring radical reform include land acquisition, labour markets, banking and state ownership of key businesses. Fiscal reform needed includes politically difficult changes in the tax base including more reliance on sales taxes and review of many poorly targeted subsidy and social welfare programs. Attempts at significant change have largely defeated successive governments over the last 25 years.

Old Problems

India appears to have chosen Mr. Modi, rather than the BJP. The government’s political and technocratic talent pool remains unknown and untested.

India’s parliament remains, as ever, the province of dynastic politicians, celebrities (primarily, actors and cricketers), rich and alleged criminals. In this election, 17% of assessed candidates faced criminal charges, including for rape or murder.

It will have to deal with internal tensions which surfaced during the election campaign, dividing the spoils of victory internally and amongst its supporters. It will have to reward its business backers instrumental in BJP’s success.

Despite oft repeated campaign mantras about the tea-seller’s son, Mr. Modi and the BJP are professional politicians, proximate to influential the wealthy and business groups. The BJP spent an estimated US$500-700 million on its election campaign, presumably financed by its supporters in expectation of favourable policy decisions.

Business interests that support the BJP are rarely interested in long term structural reforms. They favour stock market driven artificial wealth, based on preferential access to government contracts, fast tracking of approval for their projects, access to nation resources like land, commodities and spectrum at favourable prices and access to capital, from state controlled domestic banks.

On important issues, business interests have significant difference of views which will complicate policy making. In manufacturing, some believe that India has no future and should not seek to compete. Others favour high value added, advance technology manufacturing. Another group favours labour intensive low tech industries, such as clothing, leather and food processing. All groups agree, however, that the government should subsidise their preferred strategy.

See Through

Mr. Modi campaigned on an anti-corruption platform, which played well to an electorate tired of scandals.

But Mr. Modi’s desire for accountability and transparency did not extend to detailing contributions to the BJP’s coffers. It did not follow the example of the small Aam Aadmi (or Common Man) Party which discloses every donation received on its website. The fact that Aam Aadmi only won 4 seats does not suggest that the electorate or the major political players are interested in addressing India’s electoral funding system which is part of the corruption problem.

In early July 2014, Prime Minister Narendra Modi appointed a close aide and friend Amit Shah BJP President to strengthen control over the BJP and government. Mr. Shah is awaiting trial on charges of extortion and conspiring to carry out extrajudicial killings in Gujarat. Mr. Shah also oversaw the Prime Minister’s legal defence when they were charged in the 2002 Hindu-Muslim riots in Gujarat.

The actions are arguably inconsistent with Mr. Modi’s desire for fighting corruption, clean government and transparency.

Mandates of Heaven

The BJP only won 31% of the vote, while Congress won 19%. The government does not have a majority in the Indian upper house (the Rajya Shoba), commanding only 63 of the 250 seats which are elected by the state and territorial legislatures  or nominated by the President of India for their contributions to art, literature, science, and social services. The BJP will have to work with the upper house to pass major legislation related to the constitution, tax and foreign investment.

The new government will also have to work with India’s many state governments on matters which are outside its jurisdiction. The states are dominated by regional political parties who received around 50% of the national vote. The government will have to deal with a bureaucracy resistant to change and an independent central bank led by a formidable, well-credentialed Governor.

Foreign faith in its ability to reinvigorate infrastructure investment misses the point that matters like land acquisition are the responsibility of Indian states. An analysis by JP Morgan of the 50 largest stalled projects found that 55% were being delayed due state issues and another 25% due to problems of access to raw materials, controlled by government owned but independent entities such as Coal India Limited.

Mr. Modi’s Hindu nationalist philosophy and alleged complicity in the Gujarat race riots may prove divisive. The weekly magazine Open’s cover headline was Triumph of the Will, an unfortunate and hopefully unwitting allusion to Leni Riefenstahl’s cinematic chronicle of the 1934 Nazi Party Congress in Nuremberg.

The BJP Manifesto promotes building a temple to the Hindu god Ram at the controversial Ayodhya site where the Babri Mosque was destroyed in 1992. BJP supported demonstrators had committed to the Indian Supreme Court that it would not be harmed is unhelpful. The BJP Manifesto also promotes the end to the special autonomous status of the Muslim-dominated state of Jammu and Kashmir. It proposes a uniform civil code ending Islamic law within Muslim families. Hard line supporters want to expel Muslims to Pakistan.

Only around 10% of India’s substantial Muslim population voted for the BJP. During the campaign, leaders of one radical Hindu organization affiliated with the BJP argued that Indian Muslims should not be allowed to buy properties in Hindu areas. Mr. Modi disapproved of the statement. However, in Gujarat, the state of which Mr. Modi was the Chief Minster, there is strong evidence of Muslim marginalization.

Mr. Modi’s decision to celebrate his victory with a Hindu religious ceremony in the city of Varanasi was a poor signal for a harmonious secular India.

These factors will detract from social cohesion, important for economic development. It may also increase tensions with Islamic neighbours.

The decimation of Congress means India which had no government now has no opposition. There may be few checks and balances on the new government, especially given Mr. Modi’s presidential style of rule as Chief Minister of Gujarat.

Looking for Clues

The post election period has provided few clues as to how the government plans to meet the high expectations of the electorate and markets. In a statement to parliament in early June 2014, the new government announced a series of “national missions” without details of implementation.

The government committed to a “Diamond Quadrilateral project of high-speed trains”, a self conscious reference to the previous BJP government’s “Golden Quadrilateral” of highways linking major cities. The government would create another 100 new cities with “world-class amenities”. There were commitments to changes in the tax system including a general sales tax, one of the few precise proposals. India would be transformed into a globally competitive manufacturing hub, powered by “skill, scale and speed”.

The embrace of large scale infrastructure and manufacturing is interesting given Mr. Modi’s

previous stated views that India’s requirements are different from China and requires a balance between agriculture, small and large businesses.

The statement repeated the government’s “dedication to the poor”. It also committed to better education as well as toilets and broadband and Wireless Internet access simultaneously. Support for women coincided with reports of yet another heinous case of rape and murder of two lower caste women.

The July 2014 budget tellingly highlighted the constraints on the new government. Instead of the expected visionary program outlining plans for major structural reforms, it offered more of the same.

The government reaffirmed the current year budget deficit of around 4%, confirming the estimate of the outgoing government. Weak tax revenue numbers suggest that even this may be hard to meet. The forecast budget deficit was 3.6% for the next financial and 3% the subsequent year.

Unburdened by detail, the government nevertheless promised to increase economic growth to 7-8% within the next three years, reduce the fiscal deficit, increase employment and improve living standards. There were vague proposals about increasing foreign investment in defence and insurance, reduction of an ineffective subsidy regime, and tax simplification.

The government’s approach appears curious. It reverted to type relying on hoary old chestnuts -higher excise duties on cigarettes, cigars, traditional Indian paan, tobacco products and soft drinks- to raise revenue. Prior to the budget, the government was quick to implement export controls to try to rein in the price of onions.

Attempts to increase railway fares by around 14% to put the railways in a more secure financial position were seen as a willingness to push forward unpopular but necessary economic reforms. But the resolve crumbled in the face of protests from opposition parties and trade union groups, leading to a repeal of some increases on shorter journeys, which mostly affect urban customers in cities such as Mumbai, where a BJP ally the Shiv Sena is influential.

Policies to date have been inconsistent with campaign promises of deregulation and free-markets. The new government is threatening to block a global trade deal because of a separate dispute over farm subsidies.

Finance minister Arun Jaitley had, in the period before the budget promised to avoid opposed to “mindless populism”. Yet in his maiden budget, he was able to find US$33 million for the world’s biggest statue in Gujarat (Mr. Modi’s home state) of Vallabhbhai Patel, an Indian statesman. It was an amount much greater than the proposed funding for Indian women’s safety measures.

Business supporters have been forced to make excuses about the disappointments, arguing that it was early in the life of the government. The reality is that the new government’s political capital is limited and will decay rapidly over time.

Shortly after his decisive victory, the very modern and media conscious Mr. Modi tweeted “good times are coming”. They might well be but the “how” still remains frustratingly unclear.

Same Again?

Investors have forgotten that Mr. Modi’s less charismatic and less controversial predecessor Manmohan Singh, a professional economist, was once hailed by the same constituencies as India’s saviour. Mr. Singh was once the “architect of modern India” and drove important changes that paved the way for strong economic growth. By the 2014 election, Mr. Singh was seen as indecisive, weak and a puppet for interests of the Congress party.

British politician Tony Benn once observed that all political careers ultimately end in failure. It remains to be seen if Mr. Modi can bring about the necessary changes or joins an illustriously line of Indian political leaders who did not live up to their promise.

© 2014 Satyajit Das

Satyajit Das is a former banker and author of Extreme Money and Traders Guns & Money