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As India Elections Loom, the Country Weighs Economics and Reform

The UPA began its second term in 2009 amid high expectations. But scandals and a sluggish economy may open the way for others.

India’s United Progressive Alliance (UPA), a political coalition first formed in 2004 and led by the Indian National Congress party — Congress Party chair Sonia Gandhi also heads the UPA — will complete its second five-year term in May. Critics call the government the least productive in India’s history.

There was a lot of hope when the UPA assumed power in 2009. Manmohan Singh, the man who ushered in reforms in 1991, was back for his second term as prime minister and he had an A-team cabinet. The stock market cheered the victory, with the Sensex, the Bombay Stock Exchange’s benchmark index, rising 17 percent the next day.

But this optimism did not last long. During the past five years, the Indian parliament has been riven by multiple scandals: the 2G spectrum scam in 2010, in which government officials were caught illegally issuing below-market-rate frequency allocation licenses to mobile telephony companies; the 2012 coal allocation scheme, in which India’s comptroller and auditor general accused the government of corrupt parceling of coal deposits to private companies and public sector entities; and the graft associated with the country’s hosting of the 2010 Commonwealth Games. Both houses were often adjourned because of disruptions. The parliament also hit roadblocks over whether to allow more foreign direct investment in India’s retail sector and a bill introduced this year to bifurcate the state of Andhra Pradesh. The coalition government saw some partners leave and new ones enter during this five-year term.

According to PRS Legislative Research, a New Delhi–based independent political think tank, productive time in India’s lower house dropped to 61 percent from 2009 to 2014, compared with 87 percent for the previous five-year government, which also had a UPA majority. No wonder that the government passed the lowest number of bills for any full five-year-term government in the nation’s history.

The business and investing community has a strong belief that Narendra Modi, the prime ministerial candidate of the Bharatiya Janata Party (BJP)–led National Democratic Alliance, will emerge as the winner in the May elections. At firms such as Goldman Sachs and CLSA, brokers issued reports in November suggesting that Modi’s odds of becoming India’s next prime minister were strong, and that the pro-business and pro-development leader would spur business confidence and improve the investment climate. Modi has been the chief minister of the western state of Gujarat for 13 years and has impressed the business and investor community with quick decisions, on-the-ground development and economic growth. The ruling UPA, which has been slow on reforms and aggressive on social sector spending, has disappointed the business community.

On the macroeconomic front, growth has slowed in the past two years to about 5 percent, and inflation has hovered near 10 percent for most of the government’s term. India’s fiscal and monetary stimulus in 2008 was a response to the credit crisis, which resulted in lower government revenues and higher expenditures. Says Chetan Ahya, managing director and Asia-Pacific economist at Morgan Stanley in Singapore: “The government’s decision to pursue an expansionary fiscal policy to push domestic demand — through consumption — in the face of weaker export income post the credit crisis is at the heart of the macro challenges.” Says Sanjeev Prasad, senior executive director and co-head of institutional equities of Kotak Securities in Mumbai: “The fiscal stimulus was wrong, and the government continued with it for too long.”

This boost to consumption, coupled with supply-side constraints, led to inflation. Meanwhile, the Reserve Bank of India kept interest rates too low, say analysts. “Real short-term rates based on CPI have remained negative throughout the last four and a half years,” says Ahya. The consequence was a diversion of household savings from financial assets, which couldn’t beat inflation, to unproductive physical assets such as real estate, says Prasad.

The investment cycle also didn’t take off until 2011, as the corporate sector had avoided taking risks after the credit crisis and European sovereign crisis. Adds Ahya: “Even after the global environment improved, domestic factors such as corruption-related investigations, regulatory hurdles, the rise in inflation and cost of capital have held back the investment cycle.” Meanwhile UPA’s second-term entitlement programs, such as fuel subsidies and a job-guarantee scheme ensuring minimum wages, hurt India’s coffers.

With allegations of further scandals and its inability to secure commitments from its alliance partners and the opposition, the UPA government slowed down on reforms. It was only in the second half of 2012 that the government started to shrug off its economic policy inertia by freeing up foreign investment limits in retail and aviation and allowing regular diesel price hikes.

The fiscal deficit and the balance of payments situation also worsened but are getting better now. The currency too took a knock­: The exchange rate went from 44 rupees to the U.S. dollar in 2009 to 68 rupees to the dollar as of mid-March 2014 but has since recovered to around 61 rupees. Whereas some of the macroeconomic data have improved in the past few months, India is not out of the woods yet. The International Monetary Fund expects growth to slow to 4.6 percent in 2013-’14 (the Indian government calculates its fiscal year from April 1 to March 31), the lowest level in a decade, reflecting global developments and domestic supply constraints.

In the UPA government’s second term, the Sensex gained 53 percent in local currency terms but only 23 percent in dollar terms, a dismal record considering that the S&P 500 has doubled in the same period. Foreign investors haven’t lost hope, however, as they bought shares worth $24 billion in 2012 and more than $20 billion in 2013. Global liquidity, India’s relatively cheaper valuations within emerging markets and hopes of a turnaround are some of the factors that have attracted foreign investors mainly from the second half of 2012 onward.

And there is the Modi factor. Modi’s Bharatiya Janata Party is a right-of-center party that seeks to draw support from the country’s Hindu majority, which makes up more than 80 percent of the population. The India National Congress is secular and does not mind entitlements spending. The third front, a non-Congress, non-BJP alliance of regional and left parties is another alternative, but interparty rivalry may not allow it to gather steam.

Then there is the Aam Aadmi Party (AAP), or the Common Man Party, started by Arvind Kejriwal, which has its roots in anticorruption protests. Kejriwal, who has an engineering degree from the Indian Institute of Technology, was a federal tax official before getting involved with the India Against Corruption social action movement. Kejriwal’s squeaky-clean image attracted followers, and the anticorruption movement morphed into the political party. Kejriwal met with huge success in Delhi state government elections, with the AAP securing the second-highest number of seats. Kejriwal became the chief minister for 49 days but resigned after he found running the government without a majority difficult. AAP will now contest national elections, and Kejriwal is likely to take Modi head on in Varanasi, a city on the Ganges River considered holy by Hindus and Jains in the northern state of Uttar Pradesh.

There’s hope that the next government will bring the economy back on track. Says Ahya: “Following the elections, the new government will have to respond quickly to the deteriorating macro environment.” The tasks for the next government are clear: Control inflation, revive investment, boost exports and pursue stalled reforms.

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