The Indian economy continues to slow. The monthly Index of Industrial Production fell to an eight-year low in the month of September, contracting by over 4%. According to India’s central bank, growth in bank credit to industries in the same month fell to 2.7%, the lowest in a year. While the numbers for services are a little better, even they stand at a two-year low.
Economists have little faith that things will turn around on their own. The government desperately needs to revive investment. The only way to do so is to embrace something it’s avoided thus far: a true reform “big bang.”
Officials can honestly say that they’ve implemented plenty of reforms since Prime Minister Narendra Modi first came to power in 2014. In his first term, the government inaugurated a new bankruptcy code and a nationwide goods-and-services tax. It’s recapitalized and consolidated state-owned banks. In September, it slashed corporate tax rates from 30% to 22% for existing companies and to just 15% for new companies; that finally makes India competitive with the rest of Asia. The government also announced relief measures for the stressed real estate sector and unveiled new rebates for exporters.
Modi clearly prefers an incremental approach to reform, one that lessens the chances of a political backlash. He has to fear supporters as much as, if not more than the radically weakened opposition. Influential voices within the ruling Bharatiya Janata Party and its affiliates strongly oppose sweeping trade deals such as the Regional Comprehensive Economic Partnership (RCEP) and the privatization of state-owned companies.
While helpful, though, these measures by themselves aren’t strong enough to revive the animal spirits of Indian and foreign investors. India’s problems are simply too deep. The dividends from the limited reforms carried out in the 1990s and early 2000s have dwindled. The country is more integrated with the global economy — it’s signed free-trade agreements with Southeast Asian nations, Japan and Korea — which only highlights its lack of competitiveness.
Investors, including Indians who have more options now because of considerable capital account liberalization, may find it more profitable to invest elsewhere in Asia. This is particularly true of manufacturing but also of services: Even in areas such as information technology, where India was once a world-beater, rising wages have made it a less attractive place to do business.
Of course, there are multiple dimensions to this challenge. The problem of stifling corporate taxes has been addressed. But unless the cost of capital, cost of labour and cost of land come down, the overall competitiveness of the economy won’t improve enough to stimulate the interest of investors. Equally, the coddling of subpar government companies compromises the efficiency of entire sectors of the Indian economy.
The reforms required to address these problems are well-known by now. The market for capital has to be overhauled by privatizing at least two of the largest state-owned banks. The market for labour requires more flexible laws that would persuade companies to use India’s cheap and abundant workers instead of scarce and expensive capital. If China and other rivals provide land to industry for free, India cannot have a system where a huge multiple of the market price needs to be paid for land. Both failing and successful public-sector companies need to be sold.
Right now, despite recent pro-business measures, the government is sending mixed signals. Its decision to stay out of RCEP will look defensive and in favour of the status quo unless it is followed by a spate of domestic reforms. That impression could undermine the reforms already undertaken, deter foreign investors in particular and reinforce the vicious cycle which is dragging growth down.
A big bang package of reforms is more possible than nervous ministers may believe. They can spend the next two months before the next budget developing credible plans in consultation with business, civil society and the state governments. And once unveiled, the changes don’t all need to be implemented at once. A calibrated approach over 12 to 18 months would suffice; the important thing is to signal to the market that the government is serious and ambitious. By then, too, the BJP should have a clear majority in the upper house of Parliament, which will making passing bills easier.
Modi remains massively popular and can claim to have fulfilled most of the BJP’s social agenda already. But for his government to be considered truly transformative, it must revive economic growth and put it on a higher trajectory for the next two decades. There are no longer any excuses for delay.