Prime Minister Narendra Modi can’t spend too long celebrating after pushing through India’s biggest reform since the 1990s: Economists say even more politically sensitive measures are still needed.
After a decade of wrangling, the upper house of parliament on Wednesday night unanimously approved legislation to establish a nationwide goods-and-services tax known as GST. The move clears the biggest hurdle to unifying India’s 1.3 billion people into a single market for the first time by next year.
Removing a jumble of taxes on interstate trade caps Modi’s push to make India more business-friendly since his landslide victory in 2014. The reform agenda now shifts to deregulating labor and land, tasks that can be tough to reconcile with political interests among India’s rural masses — especially given key state elections in the run-up to a 2019 national vote.
“The reforms — the big ones left — are the contentious ones,” said Vishnu Varathan, a senior economist at Mizuho Bank Ltd. in Singapore. “Those would need to be handled very delicately. Getting a win in one of these would be a big leg up for the Indian economy, but they would be viewed in a mixed way as far as domestic politics is concerned.”
GST proved hard enough to pass even though most major parties broadly agreed on the concept soon after the Congress party-led government proposed it in 2006. Modi himself opposed it back when he led Gujarat state, then made a U-turn when he took national power. A frustrated and weakened Congress party then returned the favor by obstructing the bill. It finally passed after recent state elections increased the power of pro-GST parties.
For investors, a breakthrough was long overdue. Though Modi has made a number of significant changes since taking office — allowing more foreign investment, implementing an inflation target, reducing fuel subsidies — the GST has the most potential to transform what is already the world’s fastest-growing major economy. The nation’s stocks last week climbed near the highest level since August 2015.
While the tax’s ultimate economic impact depends on details that will be negotiated over the next six months or so, executives are brimming with optimism. Deepak Garg, a former McKinsey & Co. consultant, said the GST may reduce shipping costs in India by as much as 50 percent.
“This could be a game changer,” said Garg, who founded trucking company Rivigo Services in 2014. “We hope the government will move fast to simplify procedures and upgrade road infrastructure to world-class levels.”
The next steps will prove difficult, however. Farmer protests last year forced Modi to drop a proposal to make it easier for the government to acquire land for investment projects. Similarly, he has shelved plans to overhaul complex labor laws that contribute to India’s large informal economy, in part because of opposition from unions tied to his Bharatiya Janata Party, or BJP.
“Given the multiplicity of views within the BJP — not to mention among the raucous opposition parties — Modi seems fixed on an incrementalist course,” said Milan Vaishnav, a senior associate at the Carnegie Endowment for International Peace. “To date, he has been remarkably cautious in pushing reforms, taking care to minimize political risk and disruption.”
To speed things up, Modi has encouraged India’s 29 state governments to take the lead on reforms. He disbursed more funds to their administrations and sought to stimulate competition by ranking their performance in areas like setting up a business, allotting land and complying with labor laws.
It appears to be having an impact. Since Modi took office, the BJP-run states of Rajasthan, Maharashtra and Gujarat made labor laws more business friendly. Andhra Pradesh, ruled by a regional party, tripled the tenure of government land leases to industry to 99 years. And Congress-ruled Karnataka allowed shops to stay open later.
Once implemented, the GST could automatically accelerate local reforms because states won’t be able to offer tax breaks to woo companies. That means reforms in areas like land, education and the bureaucracy will “start bubbling up much faster,” said Arun Maira, a senior adviser to Boston Consulting Group and a former member of India’s Planning Commission.
GST will be “the best example of cooperative federalism,” Modi wrote on Twitter on Wednesday. “Together we will take India to new heights of progress.”
This isn’t the first time that theory has gained traction. Around the turn of the century, southern states like Andhra Pradesh, Tamil Nadu and Karnataka — home to Bangalore — began competing for IT investments.
“It was not really sustained, so I was skeptical of the notion of ‘competitive federalism,'” said Richard Rossow, an India specialist at the Washington-based Center for Strategic and International Studies who has followed the country’s reforms since the 1990s. But under Modi, he said, “real things are happening.”
There is reason to be skeptical. The GST could yet be held up at any number of steps: More than half of states need to approve the constitutional amendment, a GST Council needs to decide the rate, and parliament needs to pass at least another bill to implement the tax. Some richer states like Tamil Nadu stand to lose tax revenues and may put up a fight.
What’s more, state elections are coming into focus, including Uttar Pradesh — India’s most populous state — in mid-2017. Populist rhetoric may intensify as Modi battles to defeat caste-based parties and consolidate support among the Hindu majority. That’s all the more worrying given the impending exit of central bank Governor Raghuram Rajan, India’s chief inflation hawk.
No matter how much investors praise Modi for pushing through the GST, it’s unlikely to help him much at the polls unless it creates more jobs before the 2019 election, said Nilanjan Mukhopadhyay, a political analyst who wrote a biography of Modi. While India has no reliable jobs data, a recent poll showed that his biggest failure so far has been an inability to boost employment.
“GST was mainly a preoccupation of headline writers, politicians, business people and intelligentsia,” Mukhopadhyay said. “The people will be happy only if they think it has benefited them.”