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Global Trends and Politics

India wants to begin a new era

Prime Minister Narendra Modi has to succeed in balancing an investment-friendly economic policy with the necessity of enabling more people to participate.

14.04.2015

The Indian Prime Minister, Narendra Modi, has opened the world's most important industrial trade fair in Hanover with Chancellor Angela Merkel. This was also an acknowledgement of the ambitious economic goals of the Indian government chief, who has been in office since May 2014.

None of the world's ten largest national economies will grow more strongly than India's in the next five years. Some people see this most populated country on the planet after China, with its more than 1.2 billion inhabitants, as being well on the way to becoming the paragon of the emerging nations. Yet for a long time India was the big disappointment among the BRIC states. But things have changed. Due to its disastrous economic and political path, Russia has presumably taken over the role of the problem child for quite some time to come now. Brazil is battling recession, and China is struggling with the transformation of its economy into a viable and forward-looking growth model.

Only the outlook for India has improved. Of course, one can still find reasons to doubt the robustness of India's upswing. As one of the world's largest importers of oil, it has benefited from the drop in oil prices, so it would feel the impact when prices start to rise again. And only if the US Federal Reserve really raises its core interest rates this year will we get some indication of whether India is less susceptible to external shocks than two years ago, when capital outflows from the emerging nations also caused problems for the Indian economy and put the rupee under pressure. Furthermore, the risk scenario of an escalation of political tensions with its neighbours remains a relevant issue.

Reforms are taking effect, but they are also coming up against resistance

Prime Minister Narendra Modi has to succeed in balancing an investment-friendly economic policy with the necessity of enabling more people to participate in the current boom than was the case in the past. His announcement of extensive and courageous reforms has at least brought about a change in sentiment: escalating bureaucracy, a ramshackle infrastructure and a political sector incapable of reform held back growth and investments in India for many years.

Modi has garnered great praise from international economists for his promises to lower corporate taxes, standardising VAT throughout the country, reducing subsidies and privatising government enterprises. The opposition parties are already up in arms about measures such as the change in land acquisition laws, which favours corporate investment, but to the detriment of the rural population in particular. But if India's upper house, in which the opposition has the majority, repeatedly blocks planned reforms, Modi's reputation as the great moderniser may fade away quickly.

It is clear that India is not simply a carbon copy of the Chinese success story. Effective structural reforms and fiscal consolidation are always painful for at least some of the population. In democracies, they generally cost votes, and often even entire elections. In India, the most highly-populated democracy in the world, setbacks are to be expected. But the modernisation of the economy cannot simply be prescribed by the political sector alone. It has to have the backing – including electoral support – of the people.

Prime Minister Modi will presumably have just as little success in realising all of his election and reform promises as most newly elected governments in other countries. However, in view of the complex political processes and the pressing need for reform in the Indian economy, his successes are remarkable. For example, after many years of discussion, the limits on investments by foreign investors in the companies in the insurance industry has now been lifted from 26 to 49 per cent. It has also been made easier for foreign investors to participate in the building and railway construction sectors.

Steps towards liberalisation are being introduced in key branches of industry, such as mining. The reductions in fuel subsidies that began under the previous administration are being continued. After years of mushrooming inflation, the Reserve Bank of India is now to be given a fixed statutory inflation goal of four percent. So there are definitely grounds for optimism.

Because in the long term, the economic dynamic of a country is predominantly determined by population growth and increased productivity. The number of people of employable age in India is growing at a rate of more than one per cent each year – unlike in many industrialised nations and China, where this age group is stagnating or even shrinking. But the foundation for improved productivity is based on economic reforms.

Prime Minister Modi has taken the first important steps here, but he will be judged by his ability to hold the course he has set. With the pragmatic economic policy he has initiated in the first eleven months of his tenure, he has earned some goodwill for the tasks ahead.

Munich Re Experts
Michael Menhart
Chief Economist at Munich Re
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