Why India’s ‘pro-business’ prime minister trashed a key WTO pact

NEW DELHI, India — When Narendra Modi was elected prime minister in May, his business-friendly reputation had global markets salivating in anticipation.

So it came as something of a surprise last month when India withdrew at the last minute from a World Trade Organization pact that was designed to simplify global customs arrangements.

US Secretary of State John Kerry told Modi at a summit — designed to repair the US’s fractured relationship with India — that the move had damaged his pro-business image.

The WTO matter grabbed global headlines, but it hasn’t been the only letdown.

Most prominently, the first budget, announced after governing for 45 days, was widely viewed as a missed opportunity.

Finance minister Arun Jaitley decided not to change a target set by the previous government to reduce the fiscal deficit to only 4.1 percent by 2015 — without any significant spending cuts. In fact he introduced income tax relief — although only around 2.9 percent of Indians pay any income tax at all — without indicating how the revenue shortfall might be dealt with.

Still, foreign diplomats say there are some signs for optimism.

“What we’ve been told is that the budget is not the only opportunity to introduce fiscal reforms, so there may well be further announcements later on in the year,” one Western diplomat told GlobalPost, speaking on condition of anonymity.

“Things have [gotten] better. It’s so much easier to access the government now. They are working seven days a week and Modi is definitely cracking the whip. But there’s also some pushback from the bureaucracy. It’s hard to tell how much of it is just very entrenched interests in the bureaucracy and how much of it is inexperienced ministers trying to get on top of their briefs.”

So what can investors expect from Modi’s government in the next few months?

Last year, GlobalPost interviewed Ritika Mankar Mukherjee, an economist with Ambit Capital, one of India’s leading financial services companies. She was optimistic about the prospect of Modi as prime minister. She hoped that he might introduce a goods and services tax to increase India’s tax base, reform labor laws that she believes stifle business opportunities, and make it easier for companies to clear regulatory hurdles through “single window clearance” — allowing companies to deal with only one arm of government instead of getting tied up in red tape.

We went back to her to see what she makes of the early stages of the Modi government. (GlobalPost has edited and condensed the interview.)

GlobalPost: Modi has been in office for a few months now. What are your first impressions?

I have to say that the budget was an opportunity that India did not use optimally, for a series of reasons. The most important one was from the fiscal deficit perspective. Nobody really cared about the FY 15 number [4.1 percent] and everybody knew it was going to be difficult, but everybody did expect the new government to do justice to the sort of mandate that they had been given.

The other thing that disappointed me: If you read through the budget it sounds like a combination of multiple micro independent changes, with no overarching economic philosophy tying it all together. It was about pushing through the role of liberalisation, to improving sanitation, to providing tax exemptions, there wasn’t any sort of coherent message from the union budget and that did get me worried.

My own sense is that he is in the process of trying to put together a stronger middle management team. He has been working on realigning the prime minister’s office — making bureaucrats turn up on time for example. Each ministry is neither headed up by experienced politicians, nor is it headed by someone who is a subject matter expert.

Given the strength of the mandate, given that it was the first of a five year term, he could have done so much, he could have curtailed expenditure and nobody would have held it against him. It really really confounds me as to why they didn’t make the most of this opportunity.

When we spoke before the election, you talked about a Goods and Services Tax, labor reform and single window clearance as the three things you hoped he would introduce. Are there any signs of any of those?

I have toned down my expectations since seeing the budget. On [the Goods and Services Tax] — there were two sentences dedicated to critical indirect tax reform. [Arun Jaitley] said he would look into it this year without giving us any visibility, any timeline or deadline for it.

On revenue reforms, what he did was fairly odd in that he has given out massive tax cuts to individual taxpayers. This is going to affect the tax revenue and this isn’t something you should be doing, you shouldn’t be promoting exemptions. Ideally, you should be minimizing exemptions and expanding the tax base from a medium term reform perspective.

And single window clearance?

I think I’ll have to say it’s something that he has moved on. It’s not exactly single window clearance, but my checks do suggest that the pace of projects here that government has been giving has been systematically and structurally higher than the previous government.

The most explicit indicator of those is the stage two environment clearance for the Orissa railway lines. That was granted by the new Government after less than a month of assuming office.

So, foreign investors who might be looking at India and thinking “should I put some money in now?” — is there enough to persuade them as it stands?

While I am fairly convinced that this new government — as opposed to the twin power structure [of Sonia Gandhi giving unofficial orders to Prime Minister Manmohan Singh] that we were dealing with til this new government came along — there is responsibility and accountability in a single man, that suggests to me that this next two to three year period should see higher growth and better governance. I’m not that worried about the medium term story.

But yes, what I am telling clients and investors is “until October or November you won’t see any fireworks from a policy reform perspective” because Modi is focused on winning three critical state elections in October or November: Maharashtra which is a prosperous state — the crown jewel that has been missing from BJP ownership — Jharkhand and Haryana. And that’s point we’re making to clients: Hold on until October or November when these elections are out of the way and the government gets time to basically hire subject matter experts.

For instance, ever since Raghuram Rajan left New Delhi to become the Reserve Bank of India governor, we don’t have a chief economic advisor. Similarly the prime minister’s economic advisory council has been dissolved and no replacement has come through. So I think the union government needs time to get this state election out of the way.

Labor reform — that strikes me as one of the longer term issues that would take a lot of political will to push through. Given that the initial approach by Modi has been quite cautious, do you think he will tackle the larger issues?

I think [Modi’s] own antenna is very very pro-labor, but we will see as things do unfold. Be it a change of the factories act to enhance safety standards for laborers, or be it a change to the factories act to allow more overtime payments, the focus is likely to be on pro-labor reforms as against some hard decisions that may be resisted by trade unions. So when these state elections get out of the way, especially once they have Maharashtra in the bag – that’s when we’ll start seeing movement on genuine labor reform.

I suppose people from outside might be surprised that these three state elections are taking up significant amounts of energy for a prime minister who has won the closest thing to a landslide for more than a generation. Why is it important other than from an ego point of view to win these states?

My own sense is that he is not just focused on getting the right states, the big populous states into the BJP kitty, he is also fairly focused on being re-elected, to repeat what he did in 2014.  At this point in time Maharashtra is taking up a lot of his time. It is a prosperous state. If you want to do something like Goods and Services Tax implementation it really helps to have a state like Maharashtra on your side. So for multiple strategic reasons it does make sense to focus energies on Maharashtra. Once he does that he can focus on his five year agenda at the central level.

That would seem to indicate even after these state elections that he would have a relatively cautious approach to policy reform than a more active one. Would that be a fair assessment to make? There’s always going to be a state election.

It’s true that this is a country of 29 states and by definition there have to be at least five state elections every year. I think that Maharashtra is tactically exponentially more important than other states. This is the only major state that the BJP has not been able to capture for some time. Once he has that in the bag, he should become bolder and it does change the way he can govern.

Some of the diplomats in Delhi seem to be concerned about the recent withdrawal from the Bali deal at the WTO. They are worried this might herald a more protectionist stance. Is that something you think is likely to happen?

The big question was food security for the nation, and how serious the new government is going to be about it. The common expectation was that the new government was going to be far more right wing, far more capitalistic in terms of policies and consequently work to scale-down subsidies to farmers.

They are really serious about food security, which is why they have been so vehement about not allowing the deal to go through until they get clarity on that front. I wouldn’t read it as them wanting to be more protectionist. I don’t think that’s their point. All it’s telling me with respect to food security is that Modi is going to keep that in place.