Last year was an annus horribilis for the Indian leader.

Photographer: Mikhail Svetlov/Getty Images

Modi's Year of Possibility

Swaminathan S. Anklesaria Aiyar is a research fellow at the Center for Global Liberty and Prosperity, the Cato Institute.
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More than most world leaders, Indian Prime Minister Narendra Modi must've cheered the end of 2015. The year was an annus horribilis for him, marred by policy paralysis, embarrassing electoral defeats and mounting doubts about how transformative his term will turn out to be. He has a chance to regain momentum in 2016, but only if he's smarter and bolder about pushing his reform agenda.

India's Aspirations

Last year, voters hammered Modi in elections in Delhi and Bihar, states he'd swept in the 2014 general election. He spent much time and political capital personally leading campaigns in both states -- and worse, backed off tough reforms for fear of antagonizing this or that group of voters. The approach failed miserably, leaving him well short of a majority in the upper house of Parliament. There, opposition led by the Congress Party has stymied his two major legislative initiatives -- to relax rules on land acquisition and to create a goods-and-services tax (GST) to replace the current maze of central and state taxes.

Meanwhile, the economy remains on shaky ground. GDP growth, aided by a sharp fall in oil prices, was officially estimated around 7 percent in 2015, among the fastest globally. But many analysts say a change in statistical methodology last year has rendered growth data suspect. Nominal GDP growth in the latest quarter, measured by the old methodology, grew only 5.2 percent, a marked slowing. Corporate results were dismal in the last two quarters. The stock market, which initially boomed, ended the year in the red as foreign portfolio investors pulled billions out. Exports declined almost continuously through the year, though cheaper imports kept the trade gap in check.

Two things will likely shift in Modi’s favor this year. India suffered droughts in the last two years, so the law of averages suggests a good harvest in 2016. More important, he'll likely gain around 18 seats in the upper house after more favorable state elections in April. While that won't give him a majority, the Congress and its allies would no longer control enough seats to block the two-thirds majority needed for the constitutional amendment authorizing GST. If Modi can win over key regional parties -- and most are already in favor -- he could clinch the GST law this summer. That would be a major boost, ushering in for the first time an all-India market with uniform tax rates.

At the same time, incremental steps to improve the business climate in India are adding up. In the World Bank’s Doing Business report for 2015, India’s rank has improved from 142 to 130. India’s 2015 ranking in the World Economic Forum’s Global Competitiveness report is up from 71 to 55, and in Transparency International’s Corruption Perception Index from 85 to 75. While the country remains in the bottom half of most rankings, this should help boost investment and productivity.

Modi's efforts to expand infrastructure spending should start to show results in the second half of the year. Already road construction is up 50 percent. Capital spending in railways is rising, although it's taking time for orders to translate into production. Coal shortages have fallen sharply, while reforms in the bust electricity sector should further increase the availability of power. Modi's skillful salesmanship has spurred foreign direct investment: Electronics giant Foxconn plans to invest several billion dollars in new mobile phone factories in India.

Modi can't afford to waste this opportunity. Faced with continued legislative gridlock in New Delhi, he needs to do much more to persuade willing state governments to pass reformist laws. Already three states have enacted labor reforms that allow flexibility in hiring and firing; Modi must ensure that at least the states ruled by his Bharatiya Janata Party follow suit, offering fiscal rewards as incentive if need be. A similar approach is needed for changes to land laws, which should address acquisition, titling and ways to stimulate long-term leasing for industry as well as corporate farming.

Modi also needs to focus more on administrative reforms that don't require legislation. He should allow lateral entry into the civil service to bring sorely-needed experts from the private sector into government. Privatization of dud state-owned companies has long been discussed, but needs to become a reality. Government departments running ports and railways should be converted into corporations, with shares sold to the public to ensure lively monitoring by and accountability to investors. Given the trade slowdown, the government needs to work at reducing the time and cost of transporting and documenting exports.

Modi must think defensively as well. The main risks to the Indian economy this year will come from the deteriorating global climate, especially for emerging markets. Modi's Finance Minister Arun Jaitley wants the central bank to cut interest rates faster to stimulate investment, while Governor Raghuram Rajan is moving cautiously, giving top priority to fighting inflation. Regardless of these differences, Modi needs the well-respected Rajan on board to steer India through financial tempests that may lie ahead. Rajan's term comes to an end in 2016: Modi must move heaven and earth to persuade him to stay on. Otherwise 2016 could well end on an even gloomier note than its predecessor.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Swaminathan S Anklesaria Aiyar at swamiaiyar@gmail.com

To contact the editor responsible for this story:
Nisid Hajari at nhajari@bloomberg.net