For Modi, Diplomacy Is the Easy Part

India’s prime minister struggles at home while triumphing abroad

Operating in India for only a few months, Tony Fernandes, the Malaysian businessman who runs low-cost carrier AirAsia, has already gotten an education in the division of power between the central government and India’s 36 states and territories. With the world’s second-largest population and a growing middle-class traveling over a chronically crumbling road and rail network, India should be an easy place for AirAsia and other carriers to thrive. But the opposite is true, in part because of the high costs imposed by the states. Local politicians traditionally see air travel as a luxury for the rich, so the states have imposed some of the world’s heaviest taxes on aviation fuel, which is about 50 percent more costly than the global average. “The industry is taxed to death,” Fernandes says.

Prime Minister Narendra Modi’s government plans to open up the airline industry to more competition, with several new carriers entering the market. Modi’s aviation minister is trying to convince the states to lower their aviation fuel taxes. But thanks to India’s federal system, there’s little Modi can do as prime minister about the fuel tax.

Photograph by Kristoffer Tripplaar/Pool/Getty Images

The logjam over aviation fuel taxes is just one example of the obstacles Modi faces as he tries to revive the Indian economy. Since taking office in May, he’s enjoyed victory after victory on the diplomatic stage while making only modest progress on reforms at home. In late September he’ll have two White House meetings with President Obama, address the General Assembly of the United Nations, and appear at a rally in Madison Square Garden.

In early September, Modi achieved a long-sought breakthrough when Australian Prime Minister Tony Abbott agreed to sell uranium to India, which Australia had blacklisted for the Indians’ refusal to sign the nuclear nonproliferation treaty. Uranium imports should help Modi’s efforts to build India’s nuclear power industry.

Also in September, Modi won promises of funding for new infrastructure and industry from Japan’s Prime Minister Shinzo Abe and China’s President Xi Jinping. On Sept. 1, when Modi was in Tokyo, Abe pledged $32 billion in Japanese loans and investment, and on Sept. 18, while visiting New Delhi, Xi said China would invest $20 billion. Modi is “seeking to revitalize relationships with all the major powers in the world,” says Brahma Chellaney, professor of strategic studies at the Centre for Policy Research in New Delhi.

Back home, Modi’s been moving cautiously on reforms. His finance minister’s first budget, announced in early July, was short on specifics and incorporated large parts of the previous government’s budget. In Parliament, Modi’s Bharatiya Janata Party (BJP) enjoys a comfortable majority in the lower house, but it must contend with an upper house led by the opposition, which includes increasingly powerful local parties. India’s “fractious political system” makes speedy reforms difficult, Moody’s Analytics senior economist Glenn Levine wrote in a report published on Sept. 10.

More political challenges lie ahead. Ever since its triumph in the spring, the BJP has underperformed at the polls, most recently in special local elections in early September, when opposition parties in the key states of Uttar Pradesh and Rajasthan made gains in their state parliaments. In an embarrassing setback, the BJP even lost three seats to the opposition Congress Party in Modi’s home state of Gujarat.

There are some signs Modi’s reformist agenda is having an impact. In September the state of Andhra Pradesh cut taxes on aviation fuel to only 1 percent, down from 16 percent. Rajasthan, a BJP-controlled state, is amending laws so employers can more easily hire and fire workers. If a few states get reforms started, says Singapore-based economist Rajeev Malik of brokerage CLSA Asia-Pacific Markets, “not everyone will do the right thing, but at least the pressure will be moving in the right direction.”

    BOTTOM LINE -

    The bottom line: Modi can win pledges of billions in help from China and Japan, but he cannot lower a fuel tax at home.

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