A Crossroads for India, and Its Business Landscape - Harvard Business Review

For the first time in three decades, the Bharatiya Janata Party (BJP) has won so many seats (282 out of 543) in India’s recently-concluded general elections that it can hope to be in office for the next five years without the support of another political party. Not only does that give the BJP an unequivocal mandate for change, but also, it allows the right-of-center party to adopt a long-term perspective while making policy decisions. Most Indians are jubilant, the stock market has shot up by 20%, and, in the week after the results were announced, the Indian rupee appreciated the most among 78 currencies that Bloomberg tracks.

Although Narendra Modi, the 63-year-old former chief minister of the western state of Gujarat, will take over from an economist, Manmohan Singh, as India’s prime minister on May 26, fixing the Indian economy will, ironically, have to be the new leader’s top priority. After all, India’s growth has slowed to a crawl, with GDP expanding by less than 5% in the last two years compared to 9% per annum in the five years before 2008.

Some of the causes are well-known, such as the government’s fiscal profligacy and runaway inflation, but there has also been a fall in foreign, private, and public investment, especially in infrastructure, mining, and manufacturing, recently. That’s partly because a deadly mix of policy paralysis, rampant corruption, and bureaucratic inertia has plagued the Indian economy for the last five years.

Almost every CEO I’ve talked to, before and after the polls, believes that Modi is a shrewd, pragmatic, and decisive leader, who can kick-start economic growth and development in India by fostering a more business-friendly policy environment. What exactly does that mean in a mixed economy like India’s?

India has recently become one of the most challenging places in the world in which to do business. This is partly due to the arbitrary interpretation of tax laws by venal revenue authorities. No one can forget how the Singh government amended a law in 2012 with retrospective effect from April 1962 to force the telecom giant, Vodafone, to pay a $2-billion tax bill. Tax claims have also resulted in the closure of Nokia’s flagship factory in Chennai with the consequent loss of 5,000 jobs. Don’t expect excesses of that sort under the Modi administration; he publicly decried the previous government’s “tax terrorism” during his campaign. That should come as a relief for multinational companies that can cope with unhelpful policies, but not with policy reversals.

It’s widely believed that Modi, just as he did in Gujarat, will try to tame India’s sclerotic, corrupt, and self-serving bureaucracy by eliminating archaic laws and regulations, and by using technology to eliminate their discretionary powers. That should result in faster clearances of investment proposals, especially those from foreign companies, by the central government. However, local governments have to provide many clearances today, so the ease of doing business will differ from one Indian state to another.

Over the past five years, India developed a reputation for being the most corrupt of the major economies, but that should diminish under the new administration. Most businesspeople agree that Gujarat under Modi was less corrupt than most other states were. Modi has vowed to crack down on corrupt politicians and he will hold the bureaucracy more accountable. However, many rules, regulations, and approvals are state-level or local matters, so the mega scams may go away, but demands for bribes and speed money will not.

India could finally have elected a central government that focuses on improving its infrastructure over the next five years. Modi has said, time and again, that infrastructure development, particularly electricity generation, railroad expansion, and road building, will be his top priorities. He has a good track record in that area, with Gujarat boasting some of the country’s best infrastructure, so that may not be empty rhetoric.

At the macro level, Modi will probably strive to build a globally competitive manufacturing sector that will become India’s much-needed job-creation engine. As China’s cost competitiveness gets eroded, and global corporations reduce their dependence on manufacturing there, there’s an opportunity to get foreign companies to move their production bases to India. Given his nationalist zeal, Modi will do his best to capitalize on that opportunity. The U.S. may be on the defensive because it denied Modi a diplomatic visa in 2005, but American multinationals, like all foreign companies, will find him extremely approachable.

While the BJP government will be receptive to foreign investors, it will also pursue India’s “self-interest.” For instance, while global pharmaceutical companies and governments have been demanding stronger patent protection and an end to the compulsory licensing of drugs in India, that’s a tough call to make for the government of a relatively poor country. Similarly, India’s need to revitalize its manufacturing sector will require policy changes including reducing local content requirements and preferences for locally made goods in government purchases. Whether Modi will bite those bullets isn’t clear.

Similarly, foreign companies’ access to sectors such as multi-brand retailing, defense production, and insurance may improve more slowly than the world might wish due to the BJP’s ideological compulsions. In these contentious matters, the government will maintain a fine balance between being compliant with its obligations to the WTO, on the one hand, and doing what’s best for local business interests on the other.

Hopefully, the Modi administration will engage in a dialogue with foreign companies and governments, and search for win-win solutions rather than announce decisions unilaterally. As a result, friction on trade and investment matters should fall substantially, and economic ties with the U.S., Japan, and Europe should expand.

Thus, optimism is warranted, but euphoria is not. The Modi government, despite its mandate for change, doesn’t have a magic wand at its disposal. It has inherited high inflation, a huge fiscal deficit, and large welfare programs and subsidies that will be hard to rein in. Besides, India’s federal system ensures that state governments deal with key issues such as power distribution, education, and land acquisition. That may prove to be a problem in the 17 states where the BJP is not in power. The BJP also lacks a majority in India’s upper house, so some major policy changes, such a national goods and services tax and the reform of labor laws, could be slow.

If we were to think of the Indian economy as a flywheel, its current rotation in the wrong direction should be arrested quickly, within a year, as business and consumer confidence grows, investment picks up, and the government pursues sensible fiscal and monetary policies. However, major reforms and strengthening institutions will take time, so the flywheel may not gather speed in the right direction for the next five years.

Still, India has a chance to return to the path of rapid economic development. China has been a growth engine for the past 20 years for many multinational companies, and many are now looking for the next China. No other country is better positioned to play that role than India, where relatively modest changes in the policy environment can unleash a torrent of investment, entrepreneurship, and prosperity. more