Washington, D.C., May 13, 2014 - What a difference nine months make. The rupee has recovered from the record low last August, the stock market is up about 30% and foreign exchange reserves have been rebuilt. Overseas investors poured $14 billion into Indian stocks since then and non-resident Indians an even more substantial $32 billion. The United Progressive Alliance government's stepped-up efforts to tackle economic concerns were a key factor behind the turnaround, along with renewed global financial calm.
The markets also took big bets on a National Democratic Alliance-led government of Narendra Modi coming to power in mid-May. An electorate fed up with sub-par growth in the past several years, persistently high inflation and graft is set to oblige.
To address voter discontent, the Bharatiya Janata Party (BJP) correctly placed economic development and improved governance at the center of its election campaign and manifesto. Its first priority will be to move quickly to address impediments which have stalled nearly-completed road, power and other investment projects. The development of industrial and freight corridors, urban infrastructure and low-cost housing is set to follow shortly thereafter.
A second priority is fiscal discipline. This is to be achieved through tax reform, including the long-awaited goods and services tax (GST), along with further subsidy reduction. It also plans a simplified and non-adversarial tax environment, which is needed to give a fillip to foreign direct investment, dampened by recent tax controversies.
A third priority will be to give a boost to agriculture. The BJP is seeking to improve institutional arrangements governing agricultural marketing, pricing and distribution to create a unified market and bring about efficiency gains to tackle food inflation. In addition, the UPA government's rural jobs guarantee scheme is to be linked to farm productivity-enhancing projects.
A fourth priority will be to lift lagging manufacturing and job creation by cutting bureaucratic red tape, increasing investment in education and vocational training, fostering a conducive environment for investors and advancing labor market reforms.
A fifth priority is good governance and institutional reform for transparency, effectiveness and accountability. It also seeks greater foreign direct investment, although reversing the opening up to multi-brand retail. While the BJP is so far silent on financial sector reforms, it will probably defer to Reserve Bank of India (RBI) and Securities and Exchange Board of India, who have the primary responsibility of taking up the challenge.
The BJP is playing to Modi's strength of being able to provide a business-friendly environment and effective administration as evident from his track record in Gujarat. The influence of the old guard is on the wane along with marginalization of its fringe elements. No wonder markets are cheering. But, can Modi deliver if he wins?
The markets expect a Modi administration to move forward on its reform program augmented by efforts to improve governance. Modi's game plan also appears to be to work more closely with the states, and foster more effective policy formulation and implementation. Modi can run with many of the reform blueprints already prepared for the UPA government. In addition, he may give greater support to bureaucrats, who have been hesitant to take decisions because of the fear of investigation by independent agencies and the judiciary, which became increasingly activist in response to the graft issues of the past several years.
Under a stepped-up reform scenario, there should be a moderate increase in growth from close to 5% in 2013-14 to 5.5% in 2014-15 and 6.5% in 2015-16, spurred by revived investment, a boost to sentiment, continuing employment and income gains, and a firming in exports. A quicker turnaround seems unlikely due to the limited room for stimulus, corporate deleveraging and tightened bank lending standards. Efforts to alleviate supply-side constraints along with fiscal restraint should support the RBI in combating inflation.
With external vulnerabilities reduced, downside risks emanate mainly from domestic concerns. The key concern arises from potential post-election uncertainty. A favorable election outcome is not a done deal, and a weak coalition could trigger a financial market sell-off and adversely affect growth. Another downside risk stems from El Niño weather conditions leading to a drought. A third downside risk stems from the possibility that, even if the election outcome is favorable, Modi could disappoint. He will have to work with a potentially fractious opposition in Parliament as well as the states to advance reforms.
While the system of parliamentary and institutional checks and balances is a source of strength, it also means that leaders have to adapt to provide not only a stable but more importantly an effective government. A lot is riding on the next administration, but the elections could truly mark a turning point and a renewed virtuous cycle. India desperately needs a government which is able to meet the aspiration for jobs as well as address the issue of criminal elements in politics, and a tipping point may have been reached. Modi's track record as a reform-minded, pragmatic and efficient administrator is positive, and he should be able to follow through at the center.