The Pulse

Taking Stock of Modinomics: India’s Economic Course One Year Later

To keep India’s economy growing, Modi needs to embrace even more far-reaching reforms.

Taking Stock of Modinomics: India’s Economic Course One Year Later
Credit: Narendra Modi image via arindambanerjee / Shutterstock

It was announced recently that India’s economic growth had climbed to 7.3 percent in the fiscal year that ended in March. After some economic setbacks in previous years, India has become “a bright spot” on an otherwise fairly “cloudy global horizon” as the International Monetary Fund’s head, Christine Lagarde, put it. For India’s Prime Minister Narendra Modi, who was sworn in just over one year ago, this is excellent news. Modi campaigned on an economic platform and promised to turn India’s then-ailing economy around. More specifically, Modi cast himself as a business-oriented alternative to the socialist-leaning Congress party.

Narendra Modi can claim some credit for India’s impressive economic showing. The Modi administration’s first budget included the commitment to increase caps on foreign investment in the defense and insurance sector from 26 to 49 percent. In addition, India’s rules regarding foreign investments in construction projects have been eased. Narendra Modi also managed to secure a promise from Japan to invest $34 billion in India and China’s pledge to bring $20 billion to the table over the next five years. Furthermore, India’s corporate tax rate is supposed to be reduced from 30 to 25 percent over a four year-period.

These measures seem to be paying off. To be fair, growth estimates were already improving before Modi’s very first reform measures could be announced and India, a major oil importer, has hugely benefited from the falling oil price. However, the Modi administration has successfully appealed to a number of investors and substantially increased foreign direct investment inflows. To further accelerate economic growth and job creation, the Modi administration, however, needs to act more boldly. After having raised caps on foreign investment in two sectors to 49 percent, the Modi administration should embrace the idea of majority ownership. In addition, the administration should make good on its key promise to establish a common goods and services tax. Presently, it is extremely challenging to transfer goods from one state to another, since there are almost 20 different state taxes on commodities, which need to be standardized to boost domestic production.

The Modi administration would also be well-advised to cut India’s immense subsidies and to liberalize the country’s strict and inflexible labor laws. Cutting back on subsidy payments would reduce the deficit and — depending on the scope and focus of such cuts — facilitate trade. India’s food subsidies have been a bone of contention in India’s trade talks with international powers, particularly the United States. Last November the U.S. and India eventually agreed that India will not be challenged on its subsidies until a long-term solution is found and that New Delhi will give up its opposition to the latest trade deal, the Trade Facilitation Agreement, in return. The envisaged long-term solution, however, will be very hard to find, since India’s spending on domestic food procurements even vastly exceeds its own targets. Given the benefits of cutting subsidies, however, the Modi administration should abandon its reluctance to implement them.

Finally, India’s inflexible labor market should be modernized. Altogether there are approximately 50 laws on the federal and 150 different laws on the state level that regulate hiring practices. The Industrial Disputes Act that keeps companies with more than 100 employees from laying off workers without government permission is a case in point. As a result, companies have a huge incentive to rely on contract workers, who usually earn less than regular employees, and to invest in technology as opposed to hiring workers (fewer than 10 million Indians work in labor-intensive manufacturing industries — that number is more than ten times higher in China).

The introduction of a common goods and services tax seems to be one of the lower-hanging fruits. It is encouraging to see that the Modi administration has already set its sights on taking this step. India’s growth, however, is still hindered by its deficit, its limited trade with other countries, and its restrictive labor laws. The long-term success of India’s economy and the Modi administration depend on Modi’s readiness to go beyond pro-business reforms as India knows them and to embrace a more ambitious agenda, which should include cuts to subsidies to balance the budget and facilitate trade as well as measures to ease India’s labor restrictions to attract more investments and accelerate job creation.

Sven-Eric Fikenscher is a Research Fellow with the International Security Program and the Project on Managing the Atom at Harvard University’s Belfer Center for Science and International Affairs.