INDIA’S mammoth, five-week election, involving hundreds of millions of voters, is over. Official results were due as The Economist went to press. A new government will be formed in the coming days. Exit polls point to the Bharatiya Janata Party swooping back to power after a decade in opposition. Narendra Modi, its leader, is set to be prime minister. Investors are excited by that prospect. They like his past in running the business-friendly state of Gujarat and his talk of vikas (development) in the campaign.
Whoever becomes prime minister faces a long to-do list that includes everything from getting along with Pakistan to dealing with iron-ore mafias. But the priority must be repairing what by some measures is the world’s third-largest economy. This is the key to lifting hundreds of millions of people from poverty and creating jobs for India’s young and hungry population. It is a huge task.
A lost half-decade A decade ago India’s economy was winning new-found respect as a riot of energy and enterprise, but its performance in recent years has been dismal. Now foreign bosses roll their eyes when you mention India, as they did in the 1980s. Growth has fallen to 5%, half the level at the peak of the 2004-08 boom. Inflation and public borrowing are too high. The rupee slumped in 2013. Private firms are fed up with red tape and graft and have cut investment from a peak of 17% of GDP to 9%. On some measures the country is going backwards in time. Households have been shifting savings away from banks into the ancient refuge of gold. In a country that should be industrialising, the contribution to GDP from industry has been declining while manufacturing jobs have stagnated.
The last government dithered and was preoccupied with bolstering India’s welfare state. India’s new rulers must be more strategic and ruthless. Their task has three parts.
First, they must tackle India’s rotten banks. That might sound like a technical quibble—it is anything but. Bad debts have soared as the economy has slowed and infrastructure projects have got snared by red tape. Banks have chosen to “extend and pretend” loans to zombie firms. The cost of cleaning up banks’ balance sheets could be as high as 4% of GDP—slightly larger, in relative terms, than Wall Street’s bail out. But until the banks are fit enough to finance a new cycle of investment, no recovery will happen. Deeper financial reform is vital, too. Banks are forced to buy government bonds, giving politicians a blank cheque to borrow. Limiting that would help end the habit of reckless public deficits.
Second, a destabilising cycle of stagflation must be broken. High public borrowing has fuelled inflation, which stands at 9%. To protect their savings, households have bought gold from abroad, blowing a hole in the balance of payments. The new government must cut wasteful spending on subsidies of food and fuel. But the main reason why India has not run a budget surplus since independence in 1947 is that its tax base is puny. So the government must bring more of the economy into the tax net in order to repair the public finances.
Slaying stagflation also requires tough action from the central bank. Its chief, Raghuram Rajan, wants an inflation targeting regime. The government should back him and try to persuade him to stay in the job. To cut high food prices, it should abolish the state-run agricultural markets that are often in the hands of powerful locals who hoard farmers’ produce.
India’s not working
Creating more decent jobs is the new government’s third and most important task. Over the past half century most East Asian countries have prospered by employing unskilled farmworkers in factories. India should be doing that right now. Over 10m people a year will enter the workforce for the next decade. Labour costs are rising in China, leading firms to shift production elsewhere. Japanese companies are scrambling to diversify away from China as military tensions crackle. The rupee has fallen by a third against the yuan since 2010, making India’s workers more competitive.
So far India has blown it. For firms wanting to invest, access to the ingredients of production—energy, labour and land—is uncertain and expensive. The taxation of foreign companies is a lottery. As a result, firms such as Li & Fung, which sources textiles and toys for America’s supermarkets, say that factories are shifting to Bangladesh, South-East Asia and Africa, not India.
If India is to be in the running as a manufacturing centre, the new government must restore the country’s reputation as a place to do business. In some areas less government is needed: archaic labour laws should be abolished. In others a stronger state is required to supply reliable electricity or enforce contracts to let firms buy land. Through both, there needs to be a big drive to create clusters of manufacturing.
India can go in one of two directions. It can watch its position in the world decline as its infrastructure lags further behind and its army of underemployed people grows. Or it can stabilise its finances and build a productive private sector that creates the jobs its young people need and turns it into a serious global power. The choice is the new government’s.