Analyses
Modi's India: Rising and Reshaping
By Richard M. Rossow, Diplomat 26/4/17
Apr 28, 2017 - 12:12:39 PM

Halfway through Modi’s first term, what has the prime minister accomplished?

Since taking office in 2014, Prime Minister Narendra Modi has become India’s most powerful political figure in a generation. He is successfully leveraging a mixture of vision, slogans, reforms, and party discipline for political success. He has surprised the global community by adopting a thoughtful, robust foreign policy. Yet his government suffers from policy limitations, often driven by the same rural politics that impacted his predecessors. As we head toward India’s 2019 national election, Modi’s supporters are divided in terms of their hopes for the remainder of his term. Many would like him to use his growing authority to intensify the pace and depth of economic and social reforms. Others hope he will personally push a Hindu fundamentalist agenda. Simultaneously, the world waits to see what new foreign policy goals a stronger India will choose to pursue.

In the last 36 months, Modi has consolidated power within the Bharatiya Janata Party (BJP) and expanded his party’s reach with a string of successful state elections, while simultaneously devolving powers to India’s state governments. He is trying to replicate elements of his successful model of governance from his 12-year run as the chief minister of Gujarat — primarily by empowering key bureaucrats over political bosses in many ministries. He has avoided personally taking any decisions on the national level that would provoke fears of a Hindu nationalist agenda, while allowing junior regional party leaders to initiate such actions. His appetite for big policy steps is increasing, as evidenced by the November 2016 “demonetization” initiative. He has achieved notable reforms such as ending India’s “five year plans,” and initiated the creation of a stronger national market through the Goods and Services Tax, but also seen reforms of land and labor laws stymied in Parliament. And Modi has re-shaped India’s international relations, adopting a more “realpolitik” approach than any of his predecessors, although he remains reluctant to engage on many important global security issues.

Modi’s Inheritance: Slowing Economy; Stalled Strategic Initiatives

In the years leading up to the May 2014 election, governance and policymaking in India was chaotic. Prime Minister Manmohan Singh, who headed the Congress-led United Progressive Alliance (UPA) coalition from 2004 until 2014, was steadily losing policymaking authority to Congress President Sonia Gandhi. Important economic and foreign policy targets Singh had initiated in his early years were derailed.

Coalition partners, notably the Dravida Munnetra Kazhagam of Tamil Nadu, were using their position exclusively for party advancement instead of national development. The Congress Party’s own ministers often appeared to have different agendas than their prime minister. A notable example was Mani Shankar Aiyar’s loud flirtations with the idea of a gas pipeline from Iran whenever the U.S.-India nuclear agreement was poised to move forward.

Holding only about one-third of seats in Parliament, and with shaky coalition partners, the Congress Party could only move a limited legislative agenda using the sticks and carrots at its disposal to secure key votes. The government’s legislative priorities shifted away from economic reforms and revolved around expanding social programs and creating new protections, such as the Food Security Act and the Land Acquisition Act.

By 2014, the near-10 percent growth rates seen during the economic boom in the early years of UPA rule had been cut in half. The UPA government began to introduce a range of short-sighted measures to appease voters, such as adopting mandatory local content rules for the sale of manufactured products, or the expansion of price controls on certain goods such as pharmaceuticals.

On the foreign policy front, the United States and other emerging partners began to lose interest in pursuing deeper strategic ties with India. The U.S.-India civilian nuclear agreement suffered a near-fatal blow in Parliament in August 2010 with the passage of a deeply flawed liability law, and the United States felt betrayed over India’s decision in April 2011 not to bring the F-16 or F-18 into the final stage of bidding for the $8.2 billion “Medium Multi Role Combat Aircraft (MMRCA)” tender.

Modi’s Initial Limitations

When Narendra Modi became prime minister in May 2014, his party had the first majority in the Lok Sabha in 30 years. Still, this did not grant Modi absolute power over policymaking. Important internal and external limitations required him to adopt an inclusive agenda.

First, the BJP and its allies had a very weak position in the upper house of Parliament, the Rajya Sabha. The BJP on its own had less than 20 percent of seats in the Rajya Sabha, and coalition allies added only a few seats to this number. Modi’s legislative agenda required support from opposition and non-aligned parties, restricting the number and nature of bills he would be able to pass. Some analysts believed that Modi would resort to calling “joint sessions” of both houses of Parliament, where his National Democratic Alliance (NDA) coalition would enjoy a majority. But so far, not a single joint session has been called. And according to data from the Parliamentary Research Service (PRS), most sessions of Parliament have been relatively productive, with a few notable exceptions. In fact, of the NDA’s nine Parliament session, all but two sessions have functioned for at least 90 percent of their allotted time. Of the 15 sessions held during the UPA’s second term, 2009-2014, only three functioned for at least 90 percent of the time. The NDA has passed an average of 12.1 bills per session, compared to nine bills per session in the UPA’s second term.

Second, in May 2014 the BJP only controlled five of India’s 29 states. This limited Modi’s effectiveness on two main fronts. First, constitutional amendments require the approval of at least half of India’s states, so Modi’s ability to dramatically reshape the country’s core governance structure was limited. And second, states control most aspects of people’s daily lives. So any developments or reforms that Modi dreams up in Delhi require state leaders for partnership and implementation. So far, Modi has shown a fairly deft hand in dealing with non-aligned parties. His only constitutional amendment, the major “Goods and Services Tax” overhaul, was confirmed by a majority of states within a few months of Parliamentary approval. At the same time, the BJP has increased the number of states it controls to 13.

Third, the BJP has a strong internal faction that wants the party to focus on rolling out policies aligned with conservative Hindu values, instead of development through good economic policymaking. So far this group has not challenged Modi’s direction, at least not to the extent seen during the Atal Bihari Vajpayee government (1998-2004). But as the BJP consolidates power in India and is less reliant on regional allies for policymaking, Hindu nationalist groups’ voices may rise, demanding payment for their steadfast support of Modi.

Key Economic Policies

While predictions differed as to Modi’s approaches to foreign policy or social issues, there was wide consensus that he would focus on reshaping the economy, based on his 12-year reign as chief minister of the business-friendly state of Gujarat. These sky-high expectations have led to some dissatisfaction over the pace and direction of reforms — indeed, the expectations may have been nearly impossible to meet. Still, the Modi government has moved quickly to encourage competition among states, court foreign investment, restart stalled infrastructure projects, open new parts of the economy to the private sector, and liberalize rules around India’s oil and gas sector. A great deal of Modi’s policymaking focus has revolved around a few key “branded” themes such as “Make in India,” “Smart Cities,” “Digital India,” and “Clean India.” At the very least, adopting these flashy campaigns has helped Modi shape messaging within his cabinet.

Modi’s announcement of the twin concepts of “cooperative federalism” and “competitive federalism,” was met with equal parts hope and skepticism. The notion of getting Indian states to compete for investment is not a new one. Yet he has carried out this vision in novel ways. He disbanded the Planning Commission, creating in its stead a new organization, NITI Aayog, that has engaged states more collaboratively. NITI Aayog has, in turn, created working groups of chief ministers to review and develop policy recommendations on issues such as federal programs and encouraging digital payments. The Modi government has created new systems to rank states’ business environments. And the central government is preparing model laws for states to consider adopting.

While encouraging states to compete to bring in foreign dollars, the Modi government has taken steps to liberalize the foreign investment rules in over 30 sectors in three years — a historic pace, especially considering that relatively few sectors with foreign equity restrictions remain after 25 years of reforms. Some of these changes increased the relevant FDI cap, as with defense, insurance, and a range of other sectors. In other cases, the reform is more modest, shifting the approval process from the Foreign Investment Promotion Board (FIPB) under the Ministry of Finance, which conducts reviews of certain FDI proposals, to the “Automatic Route” under the Reserve Bank of India (RBI), which simply involves filing the correct paperwork. Apart from reducing foreign equity restrictions, Modi has taken a strong personal interest in courting potential investors. In nearly every one of his major foreign visits, public interactions with prominent business executives are a centerpiece. Contrast that to his immediate predecessors; heavy engagement with global CEOs was until recently portrayed in India as threatening a new “British Raj.”

In another step to welcome investors, Finance Minister Arun Jaitley promised during the 2014 campaign that, if the BJP were elected, they would end the period of “tax terrorism” that had chilled investor interest in India in the latter years of the UPA government. This “tax terrorism” primarily came in two forms. The first was aggressive attempts to tax investments made through tax treaty partners like Mauritius and Singapore. Vodafone became the most visible victim of this aggressive tax posture. After Vodafone won a Supreme Court decision that its investment in India’s telecom sector did not trigger a tax liability, then-Finance Minister Pranab Mukherjee amended the Income Tax Act to ensnare Vodafone in a new set of rules — potentially burdening most other foreign investors with dramatic new tax obligations. The second type of “tax terrorism” involved aggressive interpretations of the tax treatment of cross-border operations, including transfer pricing (internal cost transfers from a related entity) and permanent establishment (where income should rightfully be taxed between two countries). In office, Jaitley has moved quickly to bring certainty to the cross-border tax collection process. This includes closing the capital gains tax exemptions that had been available by investing through Mauritius and Singapore, creating stronger, more transparent rules on cross-border transactions, and changing how tax collectors are appraised in their work.

On the tax front, one specific reform stands out — the creation of a national Goods and Service Tax (GST). The GST will help turn India into a stronger national market by streamlining inter-state trade. While the final GST approved by Parliament suffers from political compromises that weaken its impact, its impact goes well beyond its direct role in the economy. The GST has become the most visible symbol of Modi’s reform program.

Modi has also devoted attention to more domestic economic issues. Infrastructure development in India, for example, has always been a tricky process. Between land acquisition, troubled payment streams, corruption in the bidding process, and over-leveraging by major developers, the incidence of “stalled” projects peaked in the last three years of the UPA government, per data from the Center for Monitoring the Indian Economy (CMIE). The proportion of stalled projects has steadily declined, though the total value of new projects has dropped in the last two years. Interestingly, project completion by public sector units has increased considerably since Modi took office, while the private sector’s completion percent has remained fairly stable. This is likely a reflection of the fact that, as we saw with Modi’s government in Gujarat, he prefers to strengthen public sector units instead of divesting them. He has some history of success in this regard, notably the electric power distribution utilities in Gujarat.

While the government's record on divesting public sector units has been underwhelming, Modi has moved forward with allowing greater private sector participation in sectors where it had previously been limited. These include the coal and railways sectors, which were opened to private commercial participation (limited participation in coal had been allowed previously), and the defense sector, which saw wide-scale deregulation. This shift also encompasses the adoption of more transparent and fair methods for auctioning government resources like spectrum and mining licenses. Modi also took the interesting step of removing the final remaining items on the list of products reserved for “Small Scale Industries,” allowing the private sector more flexibility in key sectors such as furniture production.

Since Modi assumed office, few sectors have seen a more dramatic regulatory overhaul than the hydrocarbon industry. The Modi government was quick to allow more private development of India’s vast coal resources, to deregulate diesel pricing, and to allow more flexibility in natural gas pricing. State-owned oil and gas firms were forced to shed smaller fields they had not been developing, which were auctioned to the private sector — including some foreign developers. And the new Hydrocarbon Exploration Licensing Policy (HELP), announced in March 2016, creates dramatic new flexibility in both exploration and development of hydrocarbon resources. A tenth round of oil and gas licensing expected later in 2017 will signal investor confidence in the new regime, but early feedback from the private sector has been quite positive.

While Modi has generally focused on economic liberalization as a tool for development, he has also prioritized a few social issues for “fast track progress.” This includes electrifying every village by mid-2018; bringing electricity to every home a few years later; revamping the moribund state electricity utilities through the Ujwal Discom Assurance Yojana (UDAY) bailout scheme; bringing the AADHAAR unique identity number to every citizen; providing every adult a bank account; rolling out liquid petroleum gasoline (LPG) canisters to the poor through the Ujjwala program, and more. There is a robust debate over whether the targets are reasonable, or the “quality” of delivery is sufficient. Still, there is little doubt that these areas are being transformed, even if the final product is somewhat less than promised.

Key Initiatives on Foreign Policy

Beyond commercial diplomacy, in May 2014 the world had very few clues as to how Modi would conduct foreign affairs as prime minister. As a state leader, and one in opposition for most of his tenure, he had few reasons or opportunities to paint a wider vision for how he viewed India’s place in the world. Since coming to the prime minister’s office, Modi has shown a fairly deft touch, pursuing a “realpolitik” approach to rebalancing India’s foreign relationships. India has offered crucial support to global environmental issues and Modi has engaged the Indian diaspora heavily. Modi’s major speaking events in the United States, the United Kingdom, and other countries have had a rock show atmosphere. India, however, remains largely silent on key global security affairs without an immediate impact on India’s own interests.

Many Western nations had cut off ties with Modi following religious riots in Gujarat in 2002, early in his tenure as chief minister. In the lead up to the 2014 election, as it became increasingly apparent that the BJP had an excellent chance to win the largest block of Parliament seats, the West began to tentatively re-engage. Still, there was only modest confidence that this late effort to create new bridges to Modi would be rewarded if he came to office. In this regard, Western governments missed a key point: while governments had shunned Modi, businesses and the diaspora had maintained strong ties to Gujarat. So the real starting point was not as low as was often portrayed. Furthermore, Modi was quick to reciprocate the leader-level outreach from Western nations upon taking office. Within a few months, concerns that he would “hold a grudge” had been alleviated.

Modi’s first important foreign policy decision related to his swearing-in on May 26, 2014. He took the initiative to invite other South Asian leaders to the ceremony. Many accepted, including Pakistani Prime Minister Nawaz Sharif. Sharif’s attendance attracted the most attention from international media and renewed hopes of a thaw in India-Pakistan ties. Beijing, however, was more focused on the attendance of Lobsang Sangay, the prime minister of the Tibetan government-in-exile. This was the first in a series of counter-provocations by Delhi toward its powerful neighbor, signaling to the West that India was considering a more vigorous pursuit of its regional interests.

Soon after taking office, Modi took a number of foreign trips, and hosted several foreign leaders in India. These initial engagements largely fell into three categories. First, major powers like the United States, Japan, China, and Russia. Second, Modi focused on engaging India’s immediate neighbors. Modi wanted to make sure that India restored its centrality to South Asia; several neighbors had been heavily courted by China in recent years, including Sri Lanka, Bangladesh, and Nepal. The third group included Mongolia and South Korea — democracies on China’s periphery, with which India had only nascent relations. This was another counter-provocation to China, with India showing increased ability to build ties in China’s neighborhood.

In assessing Modi’s foreign policy over three years, a few highlights stand out. He has significantly strengthened the strategic relationship with the United States, deepening defense cooperation across a range of fronts. India’s economic relationship with Japan has expanded as well, largely due to substantial new commitments by Japan’s development banks to contribute to India’s infrastructure program. And third, India and Bangladesh have made tremendous progress on strengthening connectivity and finally settling old land and maritime boundary disputes. India has also isolated Pakistan by sidestepping the South Asian Association for Regional Cooperation (SAARC), and building smaller regional groupings to focus on transportation and energy integration.

India’s relationship with Pakistan remains deeply troubled. There have been moments of cautious optimism, as Modi and Sharif met four times during the first 19 months of the Modi administration. But attacks by Pakistan-based militants started to escalate just as these leader-level summits renewed hope of rapprochement. Some of the most visible attacks were against Indian military and police targets, including Gurdaspur (July 2015), Pathankot (January 2016), Pampore (June 2016), and Uri (September 2016).

India’s security relationship with the United States has undergone an important transformation in the last three years. The path toward cooperation had been laid out to some extent by both of Modi’s predecessors. But the pace of progress under Modi has been remarkable. The two sides have put their shared interests on paper with the historic “Joint Strategic Vision for the Asia Pacific and Indian Ocean Region” and the renewed “Defense Framework Agreement.” And under Modi, the United States and India have consummated operational programs and agreements like the Defense Technology and Trade Initiative (DTTI) and the Logistics Exchange Memorandum of Agreement (LEMOA). Joint exercises have reached a new level, both in terms of number and complexity. There are also renewed hopes for civilian nuclear cooperation.

Another area of foreign policy where Modi has successfully shown global leadership is in his approach to climate change. India has a vibrant public debate over whether the country should be forced to bear the costs of “cleaner development” than Western nations or China. India has made a very strong case that the financial and technological support offered by Western countries has not materialized. Still, India offered solid commitments for the Paris Climate Change Agreement in 2015, along with impressive renewable energy targets for the coming years — hitting 175 gigawatts of renewable power by 2022.

Beyond summits, exercises, and statements, India has shown an increased willingness to intervene in regional or global crises. In April 2015 India led the withdrawal of foreigners from Yemen when the civil war there began to escalate. Also in April 2015, India led global relief efforts in Nepal following the devastating earthquake. India has also conducted a pair of limited cross-border military operations against militants in Myanmar (June 2015) and Pakistan-occupied Kashmir (September 2016). India made its first military contribution to Afghanistan’s fight against the Taliban, announcing in December 2015 that Delhi will transfer four Mi-25 attack helicopters to the Afghan National Army.

Policy Weaknesses

Overall, Modi’s track record in terms of economic reform, development, and foreign policy has been quite good. But it is far from spotless. His government suffers from many of the same ailments that afflicted past governments, often driven by deep political anxieties.

First, Modi has expanded previous administration’s affinity for price controls as a blunt tool used to “fix” a market imbalance. India continues to adopt and expand price controls in a range of sectors including pharmaceuticals, medical devices, credit card transaction fees, and more.

Abroad, this instinct for control has translated into insular trade policies. Under Modi, India delayed a pending World Trade Organization (WTO) Trade Facilitation Agreement, paralyzed existing Free Trade Agreement talks with a range of partners, slowed progress in the Regional Comprehensive Economic Partnership (RCEP) talks, and watered down its model Bilateral Investment Treaty (BIT) while forcing existing BIT partners to re-open talks based on the new model.

Modi, like his predecessors, has also been unable to curb India’s tendency toward ill-conceived regulation. India’s independent regulators, other than the Reserve Bank of India, tend to float a lot of regulatory “trial balloons” that are never adopted, act quickly on new regulations without sufficient thought or consultation, or use ambiguous terms in regulation that can raise more questions than they answer. In fact, the government’s own “Expert Committee on Prior Permissions and Regulatory Mechanism” went so far as to call for the establishment of a new body, a “Standing Committee on Regulatory Affairs,” to make sure new regulations were sensible and balanced consumer with corporate interests.

Modi’s foreign policy approach also comes with flaws. While yearning for the trappings of a recognized global power, such as permanent membership in the United Nations Security Council, India remains reluctant to raise its voice on issues that are outside of the country’s immediate interest areas. For example, India has been essentially silent on instability in Venezuela, Russia’s invasion of Crimea, and the havoc caused by Boko Haram in Nigeria.

At the time same, India has raised hackles abroad by blocking foreign non-government organizations. Although the previous government also revoked approvals for foreign NGOs to operate in India, wide skepticism remains over the types of organizations that have been targeted.

Finally, India’s defense procurement process remains slow and cumbersome. India’s military has money to spend and pressing needs for new, modern equipment, yet the slow pace of deals has undercut Modi’s otherwise forward-leaning moves to strengthen the private sector’s role in defense production. India’s liberalization of foreign investment rules in defense has also not yielded robust new proposals from foreign firms, partially due to concerns about a slow deal pipeline if they make an investment.

It is difficult to find even small signs of progress on these issues in the last three years. These policy weaknesses appear poised to continue through the remainder of Modi’s term in office.

Sustaining the Momentum: A Mixture of Devolving and Consolidating Power

As Modi passes the halfway point of this term in office, his party has a great deal of momentum and has increased its control over the levers of national power. The BJP has had major success in recent state elections, even forming multiple governments in the northeast. Foreign direct investment is hovering around all-time highs. India’s goods trade deficit is moderating somewhat and the Indian economy is recognized as the fastest-growing large economy in the world. If this energy can be sustained over the next 24 months, Modi seems to have a solid chance of remaining in office for a second term. The world will be watching closely to see if Modi’s priorities change, or if they deepen as his party’s hand strengthens over time.