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India: Modi expands power base, but reform prospects mixed

India: Modi expands power base, but reform prospects mixed

On 11 March, the federally ruling Bharatiya Janata Party (BJP) won two thirds majorities in the legislative assemblies of India’s most populous state of Uttar Pradesh and the smaller northern state of Uttarakhand. The degree of the BJP win in both states is unprecedented and cements Prime Minister Narendra Modi’s hold on power across India. 

Less flattering election outcomes for the BJP in the small states of Goa and Manipur, where the party came in narrowly behind the Congress party, may not prevent the BJP from forming the governments in these states, as it seeks to stitch together governing coalitions with local parties. And the election rout in the agricultural state of Punjab will do little to distract from the expansion of Modi’s power base. With Uttar Pradesh under its belt, the BJP now leads or is part of the administrations in states governing about 60% of India’s population. 

With no national political party currently able to offer a feasible challenge to the BJP, the trajectory appears positive in the run-up to federal elections in 2019. The BJP’s impressive performance solidifies Modi’s stature and will embolden his push for reforms in the coming years. This will be true both at the national level and in states controlled by his party. 

However, contrary to many media reports, the election results will not necessarily translate into more vigorous reform efforts across the board. Verisk Maplecroft analyses below what types of reforms Modi will likely prioritise in the coming months. 

Don't bet on federal legislative reforms

Sweeping legislative reforms in the areas of land and labour, a key focus of investors in the manufacturing and infrastructure sectors, are unlikely to materialise during the government’s current term. Failure to move ahead with such reforms over the past few years was primarily due to the BJP’s lack of a majority in the upper house of parliament. 

Despite the decisive election victory in Uttar Pradesh, a majority will be out of reach until at least 2020. That means that controversial legislative reforms will remain extremely difficult to implement during the remainder of Modi’s current term.
However, provided the BJP gets re-elected with a simple majority in 2019, as seems likely at this point, long-term prospects for legislative reforms are significantly more positive. 

Focus on administrative reforms

The picture is different in terms of administrative reforms and policy initiatives. Since coming to power in 2014, the Modi administration has demonstrated a penchant for reforms that do not require the nod of parliament. The popular stamp of approval from the election results means that Modi is now in a stronger position to make executive decisions on non-legislative issues. 

For example, at the federal level the government is now more likely to tackle the pressing issue of non-performing loans. So far, the government has only undertaken half-hearted measures to tackle the problem. Improving banks’ balance sheets is a vital pre-condition for kick starting the investment cycle as most banks’ stressed balance sheets discourage lending. The government appears very much aware of this but has evidently not had the political courage yet to push on this front. 

The surety of popular support will also make the implementation of a new Goods and Services Tax (GST), slated to be rolled out by 1 July, more straightforward. The GST will simplify and subsume many of India’s indirect taxes, but is likely to experience implementation hiccups and result in higher inflation during the first months of its existence. Modi’s strengthened political position will help him ride out any potential discontent. 

However, Modi’s penchant for conceiving his policy pushes behind closed doors also means that policy predictability will be low. Most importantly, the state election results effectively showcased that Modi’s demonetisation move, a highly controversial measure implemented in November that devalued about 86% of the country’s stocks of cash, remains popular, despite questionable economic benefits. There is now huge potential for more disruptive and controversial crackdowns of this nature. 

An issue that will be worth monitoring in this regard will be how Modi’s increasing centralisation of political powers will impact the operational autonomy of key institutions that may be perceived as obstacles to his reform agenda. Targeted institutions may include the judiciary, the central bank, and enforcement agencies, where the Modi administration has already made strides to interfere in decision-making over the past year.

State-level reforms

The outgoing state government in Uttar Pradesh has already been more business friendly than previous administrations. However, the BJP is likely to push comparatively stronger to improve the business environment. For example, it is likely to focus on digitising land records and removing remaining physical touchpoints for permit applications. Such moves would also be important measures to tackle corruption, which remains endemic in the state. 

Whether UP more broadly will become significantly more attractive for investors will however also depend on the extent to which the BJP will be able to improve the state’s dismal law and order situation. There is a credible risk that divisive rhetoric employed by the BJP during the election campaign has further deepened communal divides. Any outbreaks of communal violence would act as counter-currents to pro-business reforms.

Outlook: Investment environment will improve, with caveats

By and large investors should expect the Modi administration to use its growing political capital to implement reforms that will benefit businesses. In particular, this relates to process improvements and liberalised foreign investment rules. 

However, Modi’s intent to overhaul radically the economy does not necessarily imply policy moves that will benefit businesses. The popular endorsement the Modi administration just received for its demonetisation policy suggests huge potential for further disruptive and controversial policies that may yet contradict pro-business reforms.

By Jan Zalewski, Principal India Analyst

More in-depth analysis of the key issues impacting business in India is available via our Country Risk Monitoring Service

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