Will COVID-19 Trigger Economic Reform in India?

If it is the case that only a crisis will stimulate change in India, then now would be the time.

Expert comment Published 22 May 2020 Updated 22 October 2020 2 minute READ

Dr Gareth Price

Former Senior Research Fellow, Asia-Pacific Programme

An Indian man wearing a protective mask sits on a bench in front of a Ghandi mural in New Delhi, India.

An Indian man wearing a protective mask sits on a bench, as India remains under an unprecedented lockdown over the highly contagious coronavirus (COVID-19) on 10 April 2020, in New Delhi, India. Photo by Yawar Nazir/Getty Images.

India’s first wave of economic reforms were triggered by an economic crisis during which economic growth fell to just 1.1 per cent in 1991. With some estimates suggesting that India’s economy will contract by a staggering 45 per cent year-on-year contraction for the current quarter, there are some signs that the current crisis could trigger a change of direction in terms of economic management – though in which direction is much less clear.

Since Narendra Modi was first elected in 2014 there had been expectations – perhaps more from external observers than domestic commentators – that he would undertake the ambitious economic reforms that had eluded his predecessors. In part, the fact that the BJP was the first party in 30 years to win a majority meant that it would not be held hostage by junior coalition partners. In addition, Modi was expected to replicate the economic growth he had presided over as chief minister for Gujarat.

His first term did not meet expectations. Some long-discussed measures, most notably a nationwide tax on goods and services, were introduced but the grand gesture of demonetization in 2016 – when 80 per cent of India’s currency was taken out of circulation – caused economic hardship which was still rippling through the economy when COVID-19, and the subsequent lockdown, hit.

Since Modi’s re-election last year, the government’s agenda shifted further towards a communal agenda as economic growth slowly fell quarter on quarter. Even before the coronavirus pandemic, unemployment was thought to stand at a 45-year high.

If the pandemic were to lead to economic reform, there are contradictory signals thus far regarding the likely direction of change. One recurring theme regarding India’s economy is a widespread belief that something will happen allowing India to replicate China’s decades of double-digit growth. At the turn of the century, the idea that India would replicate in services what China did for manufacturing was widespread. This ignored the fact that India’s high-growth services sectors, such as IT, are capital rather than labour intensive, hence the familiar trope that India’s demographic dividend would ensure high growth, regardless of skills and training.

The pandemic has spurred the idea that global manufacturing will relocate to India from China. This seems optimistic. Sure, it might, but long-standing and well-known impediments to investment in India, such as red tape and infrastructure shortfalls, are likely to mean that other countries, such as those in Southeast Asia, would benefit first, this notwithstanding that the pandemic is likely to expedite the pre-existing trend for on-shoring – moving production closer to markets.

Much has been made of Modi’s statement that the pandemic showed the need for India to be ‘self-reliant’, while stressing that India would not be isolationist or protectionist. Calls for Indians to prioritise Indian products fit neatly within the general Hindutva narrative, but beyond that a return to the pre-1991 policy of import substitution seems both unlikely and in many sectors unfeasible. What is more, it would scarcely encourage foreign firms moving out of China to make India their preferred destination.

Modi’s announcement of a major stimulus package provides the greatest reason to expect the pandemic to trigger more substantive reforms. Notwithstanding that the 10 per cent of GDP figure appears somewhat creative - some reports have suggested that actual new spending is around 1 per cent – and putting to one side that most of the focus has been on the supply-side when India’s current problem is a collapse in demand, what the package demonstrates is India’s economic plight. Its ability to raise funding is limited and many of the country’s citizens – notably day labourers – are ill placed to deal with a prolonged lockdown. Just as in 1991, it may find little choice but to revisit longstanding calls for further reforms such as labour laws and bureaucratic hurdles.

India’s labour laws may offer some protection to its formal sector workforce but, as the plight of India’s migrant workers showed, they are highly irrelevant to the majority of the country’s labour force, and the evidence as to whether these laws deter firms from expansion or investment is mixed. Given the challenges of generating employment, relaxing labour laws (and applying them universally) might surely be worth trying.

While India has gradually improved in the World Bank’s ease of doing business ranking, there is clearly still room for streamlining investment. In particular, the appearance that foreign firms do not face a level playing field with domestic competitors will need to be dealt with if firms leaving China are to make India a preferred destination. For many Indians though, more important still would be agriculture reform, and the steps taken in the stimulus package do hint at wider agricultural reform.

Attempts at reform in India (and elsewhere) are often stymied by the ubiquitous ‘vested interests’. If it is the case that only a crisis will stimulate change in India, then now would be the time to expect something different and for those vested interests to be faced down.