N Chandra Mohan

Will 2014 usher in better prospects for the Indian economy? During the past year, overall growth faltered, reaching a nadir of just 4.8 percent in the third quarter. The country’s once-compelling growth story lost its luster as foreign and domestic investments were hit by policy paralysis, and clearances for big-ticket infrastructure projects were held back on environmental grounds. All these factors made 2013 a clear annus horribilis on the economic front.

On the face of it, India’s recent challenges were mirrored in other BRIC countries as well. For example, Brazil’s 2.2 percent growth, Russia’s 1.2 percent growth and China’s 7.8 percent growth in the third quarter of 2013 all indicate similar economic slowdowns. However, it is with respect to consumer inflation that India is an outlier, with prices rising by an average of 11.2 percent in November. Therefore, unlike its BRIC counterparts, India is not merely experiencing a slowdown, but rather the more serious problem of ‘stagflation’, with stagnating growth combining with rising inflation.

But with the prospects of major political change this year, some markets and investors are bullish that 2014 will be a better one for India’s economy. Hopes that the new year will herald the start of an annus mirabilis are, however, predicated on a particular outcome of the national elections in May. Foreign investors, along with large segments of India Inc, are rooting for the Bharatiya Janata Party (BJP)-led National Democratic Alliance (NDA) headed by Narendra Modi to secure a parliamentary majority. The author of the BRICs concept, Jim O’Neill, even told the Economic Times that the prospects of Modi becoming leader are bright; and that if the country as a whole could absorb his “focused decisiveness, then it would solve many of India's so-called problems overnight.”

Given Modi’s successful record in Gujarat, he is being touted as an “agent of change” who can prove equally successful in reversing the country’s economic slowdown. The verdict of the 2014 elections is, therefore, crucial for India’s future. Businesses and investors seek policy stability and a modicum of predictability, regardless of which party is at the helm. However, Congress’ failure to address retail inflation and unemployment has turned the national mood more in favor of the BJP.

There is no doubt that Modi’s campaign gained momentum in the latter part of 2013. The decisive outcome of recent assembly elections – mostly in favor of the BJP – has fuelled the growing sense that Modi could pull off a similar result in the national polls as well. However, this could be a misreading of the nine state assembly elections held over the course of 2013. The BJP remains vulnerable in the south, for example, where it suffered a humiliating defeat in Karnataka. Nor is there any discernible ‘Modi wave’ in influential states like Tamil Nadu and Andhra Pradesh. Moreover, the nine states that went to the polls last year account for only one-fifth of the Lok Sabha (Lower House) seats; they do not, therefore, constitute a representative sample of the national electorate.

Even so, there is no denying the possibility that the Modi-led NDA might emerge as the single-largest political group in the upcoming elections. If his coalition can secure 220 of the Lok Sabha’s 543 seats, that would represent a significant electoral mandate. However, in the more likely event that the BJP-led coalition’s tally does not exceed 180 seats and the Congress-led United Progressive Alliance secures around 120 seats, the divided ballot could portend further policy instability. In such a scenario, powerful regional parties would come to represent critical swing votes and would play the Game of Thrones to determine who gets appointed as prime minister.

This would be a nightmare scenario for the Modi camp. If regional parties with around 30-40 seats each are in a position to dictate the formation of the next government, the outcome might well be prolonged political instability. Already, some pundits are recalling the tumultuous 1990s, during which the country saw several prime ministers come and go without completing their five-year terms.

Nor is there any great hope that the regional parties have the wherewithal to tackle India’s economic problems. Certainly, the track record of the Trinamool Congress or the Samajwadi Party is far from inspiring. The Aam Admi Party, which swept into power in Delhi and also intends to fight in the national elections, has described itself as “socialist but not silly.” Against this backdrop, it is perhaps unsurprising that large corporations and foreign investors are hoping for a Modi win. “If Narendra Modi does storm home with a solid plurality, we could see reforms which are going to lift India's growth, not back to double-digits but maybe back to 7-8 percent," argued Nomura’s Alastair Newton.

As if on cue, a variety of agencies including the OECD and the IMF, predict a return to faster growth of 5.1 percent in 2014-15 and 5.7 percent in 2015-16. How much of this reflects the Modi-effect? Is this just a business cycle recovery, thanks to a good monsoon, regardless of who comes to power in 2014? A bountiful monsoon has certainly boosted demand in rural India for everything from cars to TV sets, leading observers to believe that the growth slowdown has bottomed out. Maruti-Suzuki, which accounts for 40 percent of the domestic automobile market, intends to expand into 100,000 villages to tap surging rural demand.

Significant structural problems will, however, confront whoever emerges as the winner of the elections. Returning to a fast growth trajectory is about institutions, strengthening the regulatory framework and enhancing the rule of law. All of this will take time to put in place before growth can accelerate to an 8 to 9 percent trajectory over the medium term. Sustaining growth also requires economic reforms across on a broad scale, which take time to properly sequence and implement. None of the major parties have so far advanced any credible proposals to address the growth slowdown.

Foreign investors are also seriously concerned about the unfriendly environment in the area of taxation. The legal threat of retrospective taxation is still in place and can only be removed by Parliament. A deal between Vodafone and the Indian tax authorities, long in discussion, appears unlikely even in 2014. Many MNCs are also facing disputes over transfer pricing – the value of which has sharply climbed from $1.8 billion in 2009 to $11.3 billion in 2012, according to the Financial Times. However, a positive development is that the tax authorities in India and the US have reportedly finalized a framework for a negotiated settlement of such tax disputes.

Boosting growth will also require a revival in manufacturing, whose share in GDP has stagnated at 15 percent. None of the major parties have articulated a strategy to promote labor-intensive manufacturing and provide opportunities for those who leave farms and head to cities for work. Against this backdrop, Bangladesh – with a fraction of its larger neighbor’s population – has overtaken India in garment exports. Organized manufacturing in India is generating only casual and temporary jobs. Although India has a surplus of labor, it faces severe skill shortages. If labor reform is necessary, it remains far from clear that the BJP or Congress can persuade their trade unions to support it.

The upshot is that there are no easy solutions to dispel India’s growth blues. A stagflationary situation means that policies to tackle growth could worsen inflation. Dealing with inflation might in turn dampen growth. The persistence of food inflation has, in fact, seriously constrained the central bank form cutting interest rates. 2014 could be an annus mirabilis if whoever comes to power takes aggressive steps to address the economy’s many and multi-faceted problems. On present evidence, there are precious few reasons to be optimistic about such an outcome.

*N Chandra Mohan is an economics and business commentator based in New Delhi

The views expressed by the author are his own.