Senior Research Fellow, Asia Programme

A combination of circumstances has suddenly raised the likelihood of a resumption of economic reform in India.

First, the nomination of Pranab Mukherjee to stand for president necessitated his resignation as finance minister. In the interim, at least, the prime minister, Manmohan Singh, has stepped in to retake the portfolio, which he previously held in the early 1990s when he dismantled the 'licence raj'. While Mr Singh had hoped that his legacy would be a rapprochement with Pakistan, equally important is the need to leave India’s economy on a sound-footing. But in recent months growth has slowed, falling to 5.3% in the first quarter of 2012 (from 9.2% in the first quarter of 2011). While high by Western standards, India needs higher growth to continue to take people out of poverty.

Time to take risks

When the economy was growing strongly, policy makers saw little reason to push through potentially unpopular reforms. But now India’s economic problems go beyond slowing growth. Inflation is rising, standing at 7.6% in May year on year. The same month exports fell by 4.2%, demonstrating India’s increasing connectedness to the global economy. The fall in exports comes despite the decline in the rupee, which is hitting all-time lows against the dollar. At the same time, the fiscal and current-account deficits are increasingly problematic.

Feeble politics

Second, the Congress-led government has been widely criticised for policy inertia, and for presiding over a host of corruption scandals. Both factors appear to have played a role in a recent string of poor performances in state elections earlier this year. The chief minister of West Bengal, Mamata Banerjee, whose party is a member of the ruling coalition has frequently thwarted proposed reforms. But with an election approaching - the general election is due to be held in 2014 – it is imperative for Congress to be seen to be taking steps to reinvigorate the economy, whether or not Ms Banerjee supports them.

This points the way to movement on issues such as liberalising foreign investment in the retail sector, a move which would not require a parliamentary vote. Foreign investment in civil aviation is also likely. While the government may be seeking alternative support if Ms Banerjee continues to agitate against economic reform, a more activist government approach towards reform would put the main opposition party, the BJP, in a difficult position. The BJP had previously supported foreign investment in retail, and its opposition is seen as politically opportunistic. If Congress were to adopt a more pro-active approach, the BJP may have to reconsider its stance on a range of issues so as to appear a party driven by principle rather than mere expediency.

If Congress does push on a programme of liberalisation, the growing fragmentation of India may become more apparent. Political parties opposed, for instance, to foreign investment in the retail sector, will have a host of tools with which to thwart it. Some state governments, such as Kerala, have already introduced measures to protect smaller 'informal' retail outlets from 'formal' retail companies, putting an additional tax on profits earned by supermarkets. (By and large, trade and commerce within a state is a matter for the state government, not the central government, according to the Indian constitution.) Furthermore, the establishment of a shop requires a host of permits, most of which are provided by the state, not the central government.

Following the state election results, Congress needs to demonstrate that it stands for something (as indeed does the BJP). While the economy was growing strongly, policy inertia was understandable. If it is to put itself in a position to win a third term, the benefits of any economic reforms would have to start to filter through before the next general election. Otherwise, and in the absence of increased policy coherence from the BJP, some form of third-front coalition containing a host of regional and leftist parties becomes the most likely option for the next government.

Also read:

Indian Politics: Heating Up
Gareth Price, Expert Comment, September 2012

Economic Reform in India: Expect Political Backlash
Gareth Price, Expert Comment, September 2012