After winning the world’s largest election, Narendra Modi and his Bharatiya Janata Party (BJP) now have the task of getting the Indian economy back on track. Holding a majority position in parliament, Modi has the mandate and the power to execute key policy reforms in order to tackle the serious problems of inflation and low economic growth.
Over the last several years India’s economy has seen consistently high levels of inflation averaging around 10%, while growth has suddenly stalled at 4.7%. Inflation is a particular worry because high rates of inflation eat away at savings, making it difficult for average Indians to purchase everyday goods.
Factors behind inflation in India are high food and energy prices, a large current account deficit, expansionary fiscal policy, delayed infrastructure projects, and inflation expectations. Raghuram Rajan the head of the Reserve Bank of India (RBI) has aggressively moved to increase interest rates in order to tamp down inflation, but he can only do so much given the distorting pressures created by government programs and market conditions.
In particular, food prices and energy prices have had both demand-pull and cost-push (supply side) inflation effects. Food price inflation within India has been driven by dietary changes, a rise in rural income, reduction of agricultural subsidies, inefficient storage of food products, and inadequate financing for repurposing farmland.
In addition, government hoarding of grain stocks and India’s grain purchasing policy has created supply side pressures increasing the cost of food products beyond healthy levels.
According to the BJP manifesto the new government intends to end this problem by stopping hoarding, curtailing black markets, creating a price stabilization fund, reconstituting the India Food Corporation to realize greater market efficiencies, distribute up to date agricultural data to farmers, and creating a single national market for agricultural products.
While some of these measures will address food inflation problems, Modi’s election promise to pay farmers a 50% profit after input costs will have the unfortunate effect of both increasing the current account deficit and inflating food prices. Energy prices have also continued to pose a significant problem to India’s economic health as outsized reliance on fossil fuel imports, weak electrical grid infrastructure, low revenue collection capacity, distorted energy pricing, and weak investment have put upward pressure on energy prices.
Modi’s energy policy as outlined in the BJP manifesto is to diversify sources of energy while building capacity at home. While concrete details have not been outlined, a way forward for developing energy capacity within India would be to relax price controls on resources like coal, improve the patchy electrical grid, and make it easier to acquire land for foreign investment. Modi has already made moves in these areas by appointing a pro-business environment minister and working to amend the Land Acquisition Act.
However, diversifying energy resources remains a problem for India. The current market is heavily dominated by fossil fuels (65%) and hydropower (19%). This means that in the short term, priority must be taken to develop stable sources of energy resources internationally.
Currently, Indian energy companies are often outbid by their Chinese counterparts and plans to develop oil pipelines from Russia pass through Pakistan or China making them politically infeasible or extremely costly. Modi will not only face tough challenges in lowering inflation, but he must concurrently build growth to improve the lives of ordinary Indians.
Domestically, the BJP is focused on investing in manufacturing, in part to address trade imbalances as well as prop up employment across the country. Further, social indicators such as women’s literacy and education, skills and training, and sanitation must be addressed in order to improve the dynamism of the domestic economy.
In a bid to address energy and growth challenges Modi plans to use the ‘garland strategy’, which means developing Indian ports similar to the Chinese development of Special Economic Zones on their coasts. Further, by developing the port system it will be cheaper for coal to be imported into India and presents an opportunity for developing coal power plants to address the energy situation.
Internationally there are several opportunities and challenges to be faced in order to grow investment and trade with India’s neighbours: China and Pakistan. There is great room for growth in cross-border trade with Pakistan but political differences arising from the ongoing concerns over terrorism have halted efforts. In a heartening sign, Prime Minister Sharif of Pakistan attended Modi’s inauguration. Sharif himself holds a majority in Pakistan, which means the two leaders have a great opportunity to amend relations and kick start trade. Whether the two pro-business leaders can reach a deal that will be lasting depends on how much compromise the military in Pakistan and hardliners within the BJP are willing to take.
Trade with China is another area that could show potential in the future. At present, China comprises 9.5% of India’s trade while India only totals 2% of China’s international trade, which is small considering the overwhelming size of each economy and relative proximity. However, China made a gesture recently to fund about $300 Billion of Indian capital investment. There are opportunities for India to address its capital stock deficiency through trade with China, which has a higher international ranking for infrastructure quality. Trade could be derailed by security concerns as the BJP does have plans to develop infrastructure in Arunachal Pradesh, an area under dispute between China and India.
As for Canada’s opportunities to improve trade exist in energy (nuclear, Liquid Petroleum Gas), machinery and equipment (infrastructure), and financing for large projects. Given the number of bilateral meetings and Harper’s commitment to trade, there exists a strong appetite to improve economic ties. Already India has already taken steps by investing in some of Alberta’s energy projects. Nuclear expertise and supplies will be an important growth area for bilateral trade as India has set a target for supplying 25% of their energy needs through nuclear power by 2050.
Another area for developing trade is in Liquid Petroleum Gas (LPG). Because roughly two thirds of the cost of LPG is in processing, Canada could have comparable prices to other LPG producing countries even with shipping costs included. Canada also represents a more stable source of energy compared to many other countries. The strength of Canadian infrastructure equipment manufacturing and services are also possible areas of growth in the future.
Modi and the BJP’s election victory has been hailed as a strong signal of a new direction for India. Optimism for change may be overblown by the reality of the pervasive economic problems which are constrained by geopolitical realities, lack of strong institutions, and complexity of governing a large and diversified country. What is certain is that Modi will have significant challenges building a prosperous, inclusive, and stronger India.
Co-written with Dr. Ram Sahi Former Director of Renewable and Electricity Policy, Government of Canada
Dr. Sahi can be reached at: email@example.com
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