Who does PMO India

Waiting for the big hit - where is India's new government headed?

After the brilliant victory of the Bharatiya Janaty Party led by Narendra Modi in the Indian parliamentary elections in May this year, the Indian economy is on the upswing. Is this recovery part of the normal economic cycle, the result of a psychological leap of faith, or are the first successes of the reform measures of the new government actually showing here?

 

The clear election victory of the Bharatiya Janaty Party (BJP) under the leadership of Narendra Modi in May of this year and the fall of the Congress Party into political
The inactivity of the lower house of the Indian Parliament came as a surprise to most observers. The fact that after 30 years one party was able to achieve an absolute majority in parliament was generally interpreted as a general settlement with the previous government and as a mandate for fundamental reforms for the BJP.

 

The majority in parliament are overestimated

The Indian majority voting system ensured - among other things through the fragmentation of the votes of relevant minorities in the northern Indian territorial states - for a disproportionately high proportion of seats for the BJP (almost 52% of the seats with 31% of the vote) and an equally distorted low proportion for the Congress party (8% of the seats with 19% of the vote). The factual distribution of seats in the lower house gave the BJP a comfortable government majority, but it did not adequately reflect the support of the population - two thirds of Indians did not vote for them - nor did it remove the opposite voting structure in the upper house.
practice, to which the opposition activity of the Congress Party has largely shifted. Both constellations can explain why the Modi government has so far only acted cautiously or cautiously with regard to reforms.

 

Economic recovery

Regardless of this, there are enormous expectations of the parliamentary majority in terms of a rapid economic upturn. The economy, shaken by a standstill and reform backlog over the past two years, suddenly switched to optimism, and share prices on the Bombay Stock Exchange began to soar after the first election forecasts, which has continued to date. And finance is giving the government and its ability to get the economy going again a great leap of faith.

The development in the second and third quarters of the financial year 2014/15 seems to confirm the confidence: according to the Asian Development Bank, growth increased to 5.7% in the first quarter (April-June), the manufacturing industry recorded a plus of 3% after a long stagnation .5%, food inflation fell slightly to 8.1% and foreign direct and portfolio investment was robust at around US $ 21 million. The forecasts of the international financial institutions for GDP growth for 2015 are between 6.0 and 6.4%. The Indian positive factors in particular should have an impact here: high savings and investment rates, a rapidly growing middle class or the politically driven increase in productivity in the manufacturing industry.

The economic recovery strengthens the position of the government, although setbacks remain in principle possible. It is still too early to be able to make reliable forecasts here. Current political decisions, such as the revocation of 214 coal block licenses by the Supreme Court in mid-September, can also weigh on individual sectors. The government announced that it would regulate the reassignment of licenses within six months in order to avoid the negative consequences for energy
industry limit.

Waiting for the big hit

However, it is already becoming apparent that the reform trees will not grow into the sky. When the interim budget was announced on July 10, 2014, it became clear that the government would take important measures such as the introduction of a uniform value added tax, the reduction of subsidies (e.g. for fertilizers
funds) and the abolition of the extremely inefficient public system for the distribution of food not - as many hoped - in a major reform
package will concern. The same applies to the opening of the energy sector to private investors and an urgent reform of labor law.

Overall, however, a major reform offensive is quite unrealistic, because some of these measures require a constitutional amendment. It would therefore not be possible to implement them even with the means of the joint meeting of the lower and upper houses, as this would require a two-thirds majority in both chambers. This is the case, for example, with the single value added tax, the main obstacle to the creation of a free Indian internal market.

The government has set the course

Nevertheless, the new government has made some key decisions. The introduction of the Financial Inclusion Scheme, which is supposed to guarantee access to bank accounts for all citizens, in combination with the Unique Identification Card, creates the prerequisites for bringing state transfer payments directly to the addressees in the future. These steps also help to minimize the susceptibility of government redistribution benefits to corruption and to increase the recipients' ability to freely use the benefits.

In this way, the accuracy of transfer payments can be increased and, in return, subsidies, from which the middle and upper classes also benefit (e.g. diesel and kerosene), can be reduced and the budget can be relieved. Furthermore, as part of the “Make in India” program launched at the end of September, the government announced a reform of labor law and the prospect of simplifying the Apprentice Law and the completely antiquated Factories Act of 1948.

An important adjustment screw for this will be the authorization of the central government to pass regulations under the Factories Act, which was previously reserved for the states. Resistance in the House of Lords, through which the member states represent their interests, should be preprogrammed. In view of a thicket of over 100 different federal and state laws, the reform of labor law will certainly be a long-term project.

Many of the regulations laid down there are also considered by Indian politicians to be hostile to growth, because they make the dismissal of industrial workers practically impossible and thus hinder the formalization of the sector and thus also harm workers. Modi has shown the greatest reforming vigor so far in the disciplining of the bureaucratic apparatus, although so far no “master plan” beyond the centralization of political power in the Prime Minister's Office (PMO) can be discerned.

The restructuring of the ministries, the upgrading of the state secretaries to decision-makers with the political backing of the prime minister as well as the strict enforcement
The setting of elementary rules in state institutions such as compliance with working hours or cleanliness were perceived as downright revolutionary in the country.
took. Provided that these measures are implemented in the long term and stringently, they have the potential to promote a sustainable improvement in government performance, including curbing the omnipresent corruption - but initially only at the central government level. To what extent the stand-
ards will rub off on state administrations remains to be seen.

While the abolition of various inter-ministerial committees, to which the former Prime Minister Singh had delegated a large part of his powers, is a clear expression of Modi's will to make decisions, the restructuring of the planning commission into an organ for collective decision-making between central government and federal states remains very vague. However, it seems unlikely that the new government will withdraw completely from detailed economic control and abandon the instrument of influence of the five-year plans in favor of long-term strategic goals.

Pro-business or pro-market?

In any case, investors should be aware that neither the new prime minister nor his party are (market) liberals and trust the self-regulatory powers of the market. Modi is primarily a nationalist who wants to establish his country as an emerging economic and political great power in a multipolar world order. Above all, he would like to eliminate those deficits that stand in the way of this claim and damage India's image. These include poor public hygiene, illiteracy, infrastructural deficits and medieval discrimination against women.

The attempt to give India a central international role is pointedly evident in Modi's lively foreign policy activities and was very special.
This can also be seen in the rejection of the WTO agreement in Bali. This also corresponds to the fact that the opening of sectors for foreign direct investment is strictly oriented towards the domestic lack of resources and the necessity of technology transfer for the Indian economy. Examples of this are the modernization of the ailing rail network as part of the construction of so-called Dedicated Freight Corridors and the construction of high-speed lines to connect the large metropolises with one another.

The tradition of purchasing foreign high technology and adapting it to domestic needs through reverse engineering, which has led to impressive innovations in the Indian aerospace industry, for example, is too protracted to meet the acute need for high technology. However, some learning processes are still necessary here: for example, the increase in the investment cap from 26 to 49% in the defense sector will probably prove to be inadequate, since hardly any foreign company is likely to undertake a substantial technology transfer to a joint venture under the conditions of a minority stake.

So what kind of economic policy approach can one expect from Modi? The experience from his home state Gujarat suggests that he will specifically strive for a coalition of “Big Politics” and “Big Business”. Systematic promotion of small and medium-sized enterprises, which provide a large part of the labor-intensive industrial production, is likely to be less important to him. The “red carpet policy” for investors practiced in Gujarat has primarily benefited major investors, to whom the then Prime Minister has given generous gifts in the form of tax breaks, land transfer and by circumventing labor and environmental law, especially in the special industrial zones.

All of this came at the expense of public investment in education and health, and had significant environmental impacts linked to the side effects
ungen of industrialization in China. The employment balance in Gujarat is also a cause for concern: According to several studies, an increasing de-structuring of employment relationships can be observed between 2001 and 2012, with which the manufacturing industry tries to evade rigid labor law. The wage level in Gujarat is lower than in other large states, labor migration is higher and the education and health indicators are worse.

The need to obtain a majority in the Indian upper house, in which heads of government of various states sit with socially and environmentally compatible, but also successful industrialization and growth strategies, will ensure that the "Gujarat model" will not be carried over to India as a whole. Small and medium-sized companies in Gujarat have undoubtedly also benefited from the expansion of the infrastructure, in particular the road network, the connection to the seaports and the stable power supply.

Balance between growth and poverty reduction

In order to be able to translate economic growth into a comprehensive development, however, it will depend on a balance between the interests of the state and the market, the pursuit of profit and the fight against poverty. Whether Modi's party is able and willing to do this will be a central question. Education and training is a relevant example: Without a shared responsibility between the state and companies for the needs-based qualification of young people for the labor market, India will not be able to realize its demographic dividend.

This requires the willingness to invest on the entrepreneurial side, and on the state side, the transfer of control over the content and structure of the training. Food inflation will not be brought under control either by the central bank's monetary policy - which will act as a brake on investment in the medium term - or by excessive subsidy programs. The decisive factor here is the elimination of market distortions through the so-called mandi system. It is a middleman system that was originally introduced to protect farmers from the market power of large companies and to guarantee them fair prices for their products. In this sense, what is needed is improved access for producers to the markets, productivity and quality increases in cultivation, harvesting and storage as well as increased processing of food.

Conclusion

This much can be said: India will not suddenly transform itself into an investor paradise with the change of government. The risks that are particularly relevant for medium-
Corporations resulting from ubiquitous corruption, unfair competition from local competitors, difficult claims management and lengthy arbitration and court proceedings will probably accompany foreign companies in India for a long time to come.

Nevertheless, gradual improvements can already be seen. In addition, the Indian market offers a wide range of business opportunities and employment opportunities, especially for German companies that will have to achieve an even larger part of their growth outside of the established markets. This applies not least to the more than 700 million largely underserved Indian consumers, to whom, however, specially adapted offers have to be made. The current government can effectively help realize this potential.

The wheel does not have to be reinvented - simply implementing the measures conceived and planned by the previous government would generate considerable economic dynamism. The specific strengths of German companies in areas such as industrial production, intelligent logistics, high technology and dual training make them ideal partners for core areas of the Modi government's growth strategy.

Dr. Doris Hillger

Dr. Doris Hillger has been Regional Manager for South Asia in the OAV's office since February 2014. Before that, she headed the New Delhi branch of the South Asia Institute of Heidelberg University and its expansion into the university-wide representation, the Heidelberg Center South Asia.