As Narendra Modi Visits Donald Trump, India’s Economic Revolution Needs a Reset

India’s Prime Minister Narendra Modi is making a working or ‘no frills’ trip to Washington.
June 26, 2017 • Commentary
This article appeared on Forbes on June 26, 2017.

India’s Prime Minister Narendra Modi is making a working or “no frills” trip to Washington. It’s a chance for him to meet President Donald Trump as they discuss what the White House calls “common priorities.” And the premier has business to conduct, including expressing his concern over proposals to restrict use of H-1B visas, which have brought many Indian professionals to America.

Some observers have highlighted similarities between the two leaders, including their nationalist/​populist message. Both emphasize business and jobs but neither believes in free markets. Both benefited from a surge in support from religious voters, though the faiths differ. Finally, critics tagged both as potential strongmen. However, PM Modi appears measurably stronger politically.

Indeed, the latter is the far more practiced politician. He led the state government of Gujarat and Bharatiya Janata Party before taking over as premier after the BJP’s overwhelming victory in 2014. The party did well last March in state elections, though it won outright only in the super‐​state of Uttar Pradesh. Still, the BJP far out‐​classed the once ruling Congress Party with a campaign that transcended caste politics, embraced Hindu nationalism, and relied on grassroots activism. PM Modi appears well‐​positioned for a repeat national victory when elections are held in two years.

Under him India has become more active internationally. New Delhi gloried in its role as a member of the “nonaligned bloc” during the Cold War. Now the bipolar world is gone and India is wealthier and ready for global leadership. President George W. Bush initiated a significant improvement in U.S.-India relations, hoping to develop New Delhi as a counterweight to China’s growing influence.

Although India has no desire to be the catspaw of Washington or anyone else, it is a natural rival to the People’s Republic of China. Their relationship remains marred by a territorial dispute that sparked a short war a half century ago. Even before the U.S.-New Delhi rapprochement, India was active economically in Burma when Western sanctions had given the PRC a near monopoly and the Indian navy was patrolling waters in Southeast Asia where local forces were dwarfed by China’s forces.

The Obama administration continued to promote good relations, as should the Trump administration, despite some concerns in New Delhi created by the president’s criticisms of the Paris climate change treaty and H-1B visas. Hopefully tonight’s White House dinner will smooth any ruffled feathers. President Trump’s apparent choice for U.S. ambassador to India, Kenneth Juster, currently serving on the National Economic Council, also should be a positive influence given his extensive experience with India. There are several areas for fruitful cooperation, including economic. U.S. officials have suggested the possibility of negotiating a free trade agreement. No formal alliance is needed; a friendly, prosperous, and democratic India naturally serves the balance of power.

It perhaps has become an international cliché, but India should follow China down the path of sustained high economic growth. With a growth rate of 7.9 percent in 2015 India has been growing faster than the PRC. Last year the International Monetary Fund forecast continued expansion above seven percent annually in coming years. Many of India’s fundamentals look solid. Inflation remains modest. India’s population is likely to surpass China’s and the McKinsey Global Institute predicted that India’s “consuming class” will triple in size over the coming decade. Entry of more women into the workforce affords India another important growth opportunity. Moreover, India’s “country risk” is below that of China, according to the Economist Intelligence Unit. Indeed, New Delhi enjoys a clear though hard to quantify advantage from democracy: Indian politics is messy, but offers a critical pressure valve lacking in the Chinese political system.

Yet there are worrisome signs that India may fall short of its potential. Some growth fundamentals remain weak. For instance, government spending rather than private investment has been driving the economy. The drop in oil prices also spurred recent growth; no similar stimulus is likely in the near future. Per capita GDP increases have not kept up. Job creation also has disappointed. HDFC Bank warned of a “growing disconnect between economic growth, education, skills and jobs.”

A number of companies fear the future. Business confidence, along with sales growth and capacity utilization, are down. In March the Economist reported that “firms are busy cutting back investment as if mired in recession. Bank lending to industry, growth in which once reached 30 percent a year, is shrinking for the first time in over two decades.”

Even the information technology sector is suffering. The Modi government had hoped to expand India’s success in information technology, proposing to wire every village as part of the “Digital India” plan. But layoffs have hit the IT sector, which currently accounts for nearly ten percent of India’s GDP. Kris Lakshmikanth, who runs Head Hunters India, said that “For the first time, companies are touching middle management.” The industry, which provides two‐​thirds of world IT out‐​sourcing, also faces foreign pressure. A related threat from President Trump is limiting use of H-1B visas, available for more highly skilled workers.

The national government has a debt to GDP ratio of 67 percent, among the highest in Asia; the 2018 deficit will be about 3.2 percent. State debt also has been increasing sharply, up from two percent of GDP in 2012 to about three percent now. Annual state deficits run about 2.5 percent of GDP. The combined national‐​state deficit is burdensome 5.7 percent of GDP.

Earlier this year states began writing off agricultural debts. In Uttar Pradesh the victorious BJP promised to waive $5.6 billion in small farmers’ loans. Farmers across the nation then demanded the same treatment. The likely result is a $40 billion write‐​off, about two percent of GDP. (The then‐​ruling Congress party took a similar step in 2008, at a cost of 1.8 percent of GDP.)

Still, the most serious barrier to an Indian economic take‐​off is India’s government, both national and state. Around the world—India’s diaspora numbers some 30 million—ethnic Indians are traders. But not in India. New Delhi and numerous state capitals simply smothered the natural entrepreneurship of the Indian people.

Collectivist, dirigiste economics reigned. The state dominated the economy’s commanding heights, imposed confiscatory tax rates, created a “License Raj” to micro‐​manage private industry, and enforced its dictates through a bureaucracy rated the worst in Asia. Even as the famed “Tigers” of Japan, Taiwan, South Korea, and eventually China raced ahead, India languished. As late as 1983 the poverty rate was an astounding 60 percent.

Meaningful reform finally came in 1991. Although the changes were sharply limited compared to what needed to be done, they were a dramatic advance over the past. Average incomes doubled within a decade and tens of millions of Indians escaped poverty. But people hoped for so much more while New Delhi again fell behind. For instance, in the 2014 Economic Freedom of the World rating, India had dropped to 112 from 102 the year before. Explained Swaminathan S. Anklesaria Aiyar in a Cato Institute study, “Although many old controls have been abolished, many still continue, and a plethora of new controls have been created.”

Expectations were great when PM Modi took over, given his pro‐​business rhetoric and positive record in Gujarat. And his government has some solid achievements, despite lacking control of the upper house, which allowed the opposition to block some measures. Modi’s administration streamlined the goods and services tax (GST), implemented a new bankruptcy code, eased restrictions on foreign investment, limited spending, eliminated capital and certification requirements barriers for business, accelerated environmental approvals, and improved public administration and infrastructure. Chandrajit Banerjee, Director General of the Confederation of Indian Industry, praised the “impressive agenda of innovative economic reforms and social programs that have positively impacted growth.”

However, some of the premier’s supporters have been disappointed, given the magnitude of the changes yet needed. For example, Shankar Acharya, a columnist for New Delhi’s Business Standard, worried: “Economic reforms have clearly lost momentum and there is a sense of drift in economic policy.” The Times of India editorialized that “the government hasn’t pressed the pedal hard on reforms” and “implementation of projects” has been slow. The Economist saw a cavalcade of mini‐​initiatives rather than a serious reform program.

Despite BJP rule, the 2017 Index of Economic Freedom rated India at only 143 of 180 countries. In contrast, China stood at 111. Moreover, New Delhi’s rating fell from the year before. India performed particularly poorly on business freedom, financial freedom, government integrity, investment freedom, judicial effectiveness, and labor freedom.

PM Modi’s ability to effect change will improve as the BJP makes additional gains in parliament’s upper chamber. However, the premier is more like Donald Trump than Ronald Reagan, to whom he was originally compared, in that he believes in managed rather than free markets. In fact, the BJP has, in the words of the Carnegie Endowment’s Milan Vaishnav, a “nationalist, protectionist wing” with which President Trump would be comfortable. Moreover, despite PM Modi’s dominating role, he “seems stuck in the mindset of a provincial executive: he is more interested in projects than in policies; he is a modernizer, not a reformer,” observed Sebastian Mallaby of the Council on Foreign Relations. The Economist similarly termed the premier “a fine administrator but not much of a reformer.”

The government often has manipulated rather than freed the market. For instance, New Delhi imposed agricultural prices controls and criticized “hoarding,” Officials also have discussed recreating state monopolies in “strategic” economic sectors, Particularly harmful was last November’s currency “reform,” by which 86 percent of the nation’s currency was demonetized without an adequate number of new bills available. The result was chaos for all and ruin for some, particularly small, cash‐​based businesses. Currency shortages in ATMs persisted until last month. Saurabh Mukherjea of Ambit Capital described demonetization “as the economic equivalent of a heart attack.”

PM Modi moderated the political blowback by playing the populist card, arguing that the program was necessary to tame the rich and stop corruption. But whatever the economic justification for moving the economy away from a disproportionate reliance on cash, the government appeared motivated more by the desire to bring the nation’s finances under its control. The botched swap probably accounted at least partly for the lower annualized growth of 6.1 percent during the first quarter of this year, below the rate when PM Modi took office. And the impact could last for some time.

The premier should shift course and use his authority, strengthened by the March elections, to accelerate reforms. Much could be done to liberalize markets, encourage entrepreneurship, ease business creation, and spur employment. For instance, Cornell’s Eswar Prasad of Cornell advocated “reducing labor regulations, unshackling businesses from red tape and bureaucracy, reducing government control of banks and clearing up their bad loans, developing capital markets, revamping the government’s tax and expenditure systems and improving infrastructure.”

Of particular concern, the rules governing business hiring and firing greatly increase costs, discouraging job creation. Employment actually has fallen in these areas, while growth has been limited primarily to uncovered industries. Regulated companies tend to stay small and rely on temporary labor. India hosts only 270 firms with sales above $125 million, compared to 7,680 in China. Nine out of ten jobs come from the informal sector. This system has greatly hindered development of a competitive manufacturing industry, like that in China. India’s abundant human resources are being squandered.

Government enterprises are used to provide jobs. Even in a good economy losses are routine. Firms that make money usually rely on government monopolies or other special privileges. Air India loses more money the more it flies. Overall, parastatals lose billions of dollars a year. They survive only at extraordinary public cost: “soft loans, subsidies, and bail‐​outs keep them afloat,” observed the Economist.

State banks are loaded with bad debts which McKinsey & Co. figures exceed the banks’ total value. Government “services” are a scandal. Said Aiyar, “With almost no exceptions, the delivery of government services in India is pathetic, from the police and judiciary to education and health.” Many teachers in public schools don’t even bother to come to class. Lawsuits can take decades to resolve: the legal system has a backlog of 31.5 million cases.

PM Modi also should avoid the temptation to inflame Hindu nationalism to win votes. Religious intolerance and persecution have worsened since his 2014 victory. Vigilantism has been rising, especially against Muslims accused of trafficking in beef. Yet after the BJP’s victory in Uttar Pradesh he appointed as chief minister a Hindu priest once jailed for his violent rhetorical attacks on Muslims. Even if such tactics yield short‐​term political benefits, they risk not only social conflict but economic harm, discouraging foreign investment and trade which would benefit all Indians.

Just as the world spent decades waiting for China to escape Mao Zedong’s communist madness, so, too, has the world spent decades waiting for India to leave behind Jawaharlal Nehru’s socialist nostrums. PM Modi offers competent management and has moved his country closer to economic freedom. But getting the rest of the way requires freeing India’s people from the shackles created by government social and economic engineers. Ethnic Indians have proved their economic prowess around the globe. Now they need the chance to do so at home.

It is good for the prime minister to visit America early during the two leaders’ joint tenure. Although no one knows how two such egos that have climbed the political mountains in their respective nations will get along, Narendra Modi is a worthy partner for Donald Trump. Both have succeeded in tough political systems and overcome harsh opposition. And both have a unique opportunity to transform their respective nations, and ultimately the world. Working together they are more likely to succeed in doing so, and for the better.

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