The world’s largest democracy goes to the polls this month. The collective wisdom of 800 million people is likely to produce an outcome that could have huge implications for the global economy. Recent exit polls project a win for the coalition led by the pro-business Bharathiya Janata Party (BJP), headed by Narendra Modi, whose promises include “minimum government and maximum governance”. Financial commentators and pundits seem to have taken to overly simplifying the election outcome in binary terms. A win for Mr. Modi would mean reforms and rapid economic growth while any other outcome would be an absolute disaster for the Indian economy. In a complex country like India the truth lies somewhere in between.
To say that the last twelve months have been challenging times for the Indian economy would be an understatement. First came the ignominy of being part of the underperforming BRICS (Brazil, Russia, India, China and South Africa). Then came the dubious honor of joining the Fragile Five, a term coined by Morgan Stanley for countries with high inflation, weak currency, slumping growth and large external deficits. With this in mind, does a new elected government really have a chance of reviving the economy? The Indian stock market definitely seems to think so and it has seen a strong rally since the first exit polls started coming out in February 2014. But investors must realise that this is a hope-based rally. The hard reality of fixing a complex economy like India will set in once the election fever subsides.
Mr. Modi’s pro-business credentials and his reputation for speedy execution have raised expectations among the Indian public and foreign investors that a wave of his magic wand will heal India of its self-inflicted wounds. But historic precedent suggests that the impact of structural reforms is felt many years after the first shot at fixing a country’s problems. Take the case of Brazil, whose cycles of boom, bust and chronic inflation made it a basket case of economic mismanagement in the 1970s and 1980s. It took a visionary in the form of Fernando Henrique Cardoso to break the back of inflation and pass through reforms that succeeded in putting Brazil on the economic map. His time as finance minister and two terms as President from 1995 to 2002 set the foundation for Brazil’s rapid growth trajectory. It took close to ten years of reform before results were visible to the Brazilian public and the investment community at large. Successive governments under Presidents Lula Da Silva and Dilma Rouseff have ridden the wave created by President Cardoso.
The lesson from all this is that deep structural reforms take time to be implemented and it takes years before they show up as solid economic growth. A recent report by Credit Suisse indicated that only a quarter of investment projects in India are stuck under the federal government. This means Mr. Modi will need active cooperation from the State governments to implement reforms and push through investments. In India’s cacophonous democracy, implementation is bound to take time. Also, most of the “easy” reforms have already been implemented leaving the new government with the unenviable task of pushing through tougher unpopular reforms to correct the course of the economy. These include labour reform, reforms in land acquisition, judicial reform, streamlining India’s gargantuan bureaucracy and allowing FDI in retail.
Even with the best-case scenario of having a federal government with a strong mandate, it could take two years to start seeing results on the ground. The challenge of doing all this while keeping a lid on inflation and rising unemployment will be no mean task.
So why the urgency to implement the above mentioned reforms? As noted in The Emerging Market Handbook, the simple one-word answer is demographics. There is no precedent in world history where one nation has been gifted with so many young people entering the workforce at the same time. With an average age of 28 years, India’s demographic edge is expected to last another 40 years. The next ten years will be crucial to reap the benefits of this enormous “natural resource”. A resurgent Indian economy has the capacity to carry global economic growth on its back the way China has done for the last two decades.