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The Modi government is taking a long-term perspective with its reform agenda.

India: Short-term pain, long-term gain

Negative news reports about reforms in India tend to ignore all of the positive changes taking place.

Many news outlets have cast a critical eye on the rapid changes taking place in India. This has been the case from the time Prime Minister Narendra Modi came into power and regardless of any progress on reforms the government has made. While a more casual observer might be concerned about the negative tone of these reports, we take a different perspective.

The truth is, reform can be quite painful, which is why in many developed and developing countries, politicians and governments often avoid it. India is fortunate to have a government that doesn’t prioritize growth at the expense of delivering reforms that have been needed for decades, but that previous governments have been unable to implement. Instead, the Modi government has been willing to sacrifice short-term growth with the aim of improving India’s long-term fundamentals.

The government has indeed delivered significant reforms. While it may take some time to fully recognize the benefits of the demonetization policy and how it has helped address corruption, we have capital that is now taxable start to enter the banking system. The political effects have been even more profound. Campaign financing has been significantly curtailed, putting the opposition parties in an awkward position in the run-up to important state elections and the national election in 2019.

The government has indeed delivered significant reforms.

Ordinary citizens have been encouraged by seeing a politician willing to at least try to address corruption in the economy and politics. The result was a thumping victory in the Uttar Pradesh state election that left opposition parties battered and bruised. Another victory was the defection of Nitish Kumar, the former Chief Minister of Bihar (a state the Bharatiya Janata Party, or BJP, previously lost), to Modi.

The Goods and Services Tax (GST) has been one of the most important reforms ever delivered, and certainly the most important tax reform. Getting it passed into law not only involved the central government but also their relationship with India’s states, which ultimately have to accept, adopt and implement the proposed law. It says a lot about the current government that they have been able to mend many bridges with the states in order to get to a point that the law would pass. It may not have been in the most desirable form, but it is a huge step forward.

There will of course be a short-term negative impact, as many economists have predicted. Businesses have to change tax policies and IT systems, and get familiar with the new tax policy. But economists also know that this should normalize and help deliver significant long-term gains.

At the same time, India has some of the largest infrastructure projects going on anywhere in the world, such as the construction of massive freight transport systems that are expected to be completed beginning in 2019 and will join up huge swathes of the country. This will go a long way toward reducing logistics costs and increasing productivity. Combined with the GST, these efforts should help open national markets for goods and facilitate new business areas like warehousing and logistics. This is the ultimate prize and quite rightly the long-term focus of the Modi government.

Investors shouldn’t overlook the fact that the government itself has been reformed in recent years. Decision-making has become more streamlined, government ministries more focused and performance scrutinized, resulting in far greater productivity. This has allowed a record number of bills to be passed, given a green light to many stalled projects and turned around a number of previously underperforming sectors like the coal industry, which now has surplus output. Furthermore, multi-national companies have reported that corruption at the higher levels of government has all but disappeared.

And that’s not all. In addition to the implementation of the GST, key reforms like the passage of the Reserve Bank of India (RBI) Act, the formation of the monetary policy committee, the establishment of an inflation-targeting framework and passage of the Bankruptcy Code have strengthened the nation’s finances. Liberalization of foreign direct investment (FDI) has led to some of the strongest growth in FDI flows in any country and moved India towards a positive basic balance of payments.

Technology has also brought about positive changes. The adoption of technology to enable monitoring of projects, policies and the government itself has helped identify and address problem areas, fast-track solutions and allow many previously stalled projects to move forward. Technology that allows online tax filing as well as requests for business permits and approvals has reduced the time for starting a business from months to a week, and has partly been responsible for India’s rapid ascent of the World Economic Forum’s Global Competitiveness Report rankings in recent years. Finally, the Aadhaar program, which has provided a biometric ID to majority of India’s population of 1.3 billion people ahead of time and ahead of schedule, has already reduced leakages in the system, as subsidies can be targeted and paid in bank accounts quicker, while at the same time enabling a digital platform for all kinds of e-commerce and facilitating the penetration of banking services into previously un-banked rural areas.

Technology has also brought about positive changes.

Judging the BJP’s success or lack thereof by its inability to implement reforms in two key areas, namely land and labor reforms, belies two key political realities. First, the BJP doesn’t control the upper House of Parliament. Second, these measures could be even more difficult to pass and implement than the GST due to their highly contentious nature. One maybe forgets that the BJP expended significant political capital on these early in its current term and had nothing to show for it. Given that the BJP require support not just at the central government but at the state level, Modi must play the long game, starting with a focus on gaining control of the upper House of Parliament through successive state and national election victories, a process which has already begun.

While some media outlets may question Modi’s leadership, we believe this may be short-sighted. There was a lot of criticism aimed at the government following the implementation of the demonetization policy, and yet Modi’s popularity on the ground was so strong that his party won the Uttar Pradesh state election by the largest margin in over 10 years. We suspect that when 2019 comes around, the realization of just how strong a position Modi is in will once again be made abundantly clear.

Important Information

Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.

Editorial image credit: Stock Illustrations / Alamy Stock Photo

ID: US-111017-48910-1