India’s New Tax Isn’t the Last of Modi’s ReformsBy
Government to carefully monitor inflation, price stability
Politically-sensitive land, labor reforms may be out of reach
With a landmark goods and services tax now rolling out across India, Prime Minister Narendra Modi is likely to turn his focus to job creation and other key economic reforms.
Further big structural steps, such as revamping India’s land acquisition and labor laws, are unlikely to occur before the next national election, scheduled for 2019, as Modi’s Bharatiya Janata Party still lacks a majority in the upper house of parliament.
Instead, analysts suggest the BJP is likely to focus on creating jobs while it pursues smaller reforms, including on administrative measures, anti-corruption policies and tax evasion. While India remains one of the fastest growing economies in Asia, employment creation was the slowest on record in 2015, with just 135,000 net new jobs in the formal sector of the economy against the 12 million estimated new entrants to the workforce, government data show.
At the same time, Modi’s administration will also have to dedicate considerable resources to ensure the success of the new, nation-wide GST, which took effect on July 1 after a midnight launch ceremony and has already caused some economic disruption.
“Modi will want to ride on the coat tails of the GST success to make additional progress on the economic reform front,” said Michael Kugelman, a senior associate for South Asia at the Woodrow Wilson Center in Washington, D.C. “In particular he’s going to be focused on job creation. Modi remains popular in India, but the job issue is one area that could be a political liability for him and his party both in state and national elections.”
More urgently, Modi’s party will need to make sure the GST implementation goes smoothly and does not lead to a spike in inflation or sustained economic chaos. Despite a relaxation of initial filing requirements, there are early signs that businesses remain confused and consumers might be putting off purchases.
“Politically selling the GST and ensuring there are no wrinkles will take the best part of the next six months, if not longer,” said Ashok Malik, a distinguished fellow with the New Delhi-based Observer Research Foundation think-tank.
Given indirect taxes on almost 50 percent of the CPI basket are expected to come down under GST, the new tax is not expected to be inflationary, said Sujan Hajra, chief economist at Anand Rathi Financial Services Ltd.
"Prices are expected to decline under GST and inflation is the only link between RBI monetary policy decision and GST," Hajra said. "That will open an elbow room for RBI to cut rates -- we expect the central bank to ease the repo rate by 25 basis points in August as inflation is low.”
If the GST-related disruption continues, it would be the second big hit to economic activity in less than a year, after Modi’s government demonetized the country’s high denomination notes last November, effectively eradicating 86 percent of currency in circulation.
“If that happens, it will provide political fodder for a beleaguered opposition in the run-up to elections in Modi’s home state of Gujarat,” said Pratyush Rao, a Singapore-based senior analyst for South Asia at Control Risks, a consultancy. Fear of significant political backlash in the lead up to the 2019 elections is likely to reduce the BJP’s appetite for riskier reforms, Rao added.
“Overall, we are likely to continue seeing a preference for an incremental approach towards reforms, one that prioritizes administrative reforms over structural ones.”
Still, in the days before the GST was formally rolled out, Modi’s government was already by asking the finance ministry to suggest ways to potentially privatize the debt-laden the indebted state carrier Air India.
Even as the government tweaks the GST roll out and attempts to sell off the state airline, Modi’s administration is likely to continue policies that build on the legacy of his three-year reign while campaigning across the country to increase the BJP’s chances of securing a second five-year term.
“You’re likely to see some measures on tax avoidance and corruption, some sort of crackdown on high profile cases,” Malik said, adding that big structural economic reforms are now unlikely. “I think he’s done enough for his first term.”
The BJP is also likely to try and expand its base of support beyond north India by making political inroads in the southern state of Tamil Nadu, the eastern state of Odisha and attempting to shore up alliances in Andhra Pradesh and Telangana, said Shailesh Kumar, a Eurasia Group senior analyst for South Asia.
“Along the way, the administration is also going to do everything it can to keep inflation low as price stability will be critical for his electoral chances,” Kumar said. “This will have the added benefit of supporting additional inward investment, which has become an important driver of economic growth.”
Currently, bigger structural reforms are still stymied by the BJP’s lack of a majority in India’s Rajya Sabha, or upper house of parliament.
That means Modi’s party has been unable to push through politically-sensitive changes to the country’s land and labor laws, despite the BJP having a majority in India’s lower house of parliament, the Lok Sabha. However, the situation in the upper house should eventually improve if the BJP keeps winning state level elections the way the BJP won big in Uttar Pradesh, the country’s most populous state at 200 million people.
“It will open the door for ambitious, sweeping economic reforms that could lift India’s medium-term growth rate,” said Rajiv Biswas, Asia-Pacific chief economist at IHS Markit.
“These could include long delayed reforms to land acquisition laws that should catalyze industrial investment as well as further foreign investment liberalization and additional financial services reforms.”
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— With assistance by Divya Patil