Indian Prime Minister Narendra Modi has lost a critical state-level election. Does it mean the end of economic reforms for India?

There were fireworks at the Patna regional headquarters of India’s Bharatiya Janata Party (BJP) on the morning of November 8. Early trends seemed to indicate that the BJP, the party backed by Prime Minister Narendra Modi, would win the Bihar state-level elections hands down. But it was not to be. When the final results came in, it was the Grand Alliance—a group of often-warring parties—that walked away with the victory. The BJP functionaries took things in their stride. They even sold to the winners the stockpiles of firecrackers they had accumulated to celebrate a victory (the BJP is, after all, a party of small businessmen and traders) and disappeared into the woodwork.

But fresh fireworks were to follow. Four BJP “elders” issued a joint statement calling for a thorough review of the reasons for the Bihar debacle. Instead of development and economic reforms being the key issues, the debate was hijacked by Modi’s personality. His detractors on the outside saw the election loss as being a backlash against Hindu fundamentalist intolerance. Inside the National Democratic Alliance (NDA), the BJP-led coalition that Modi heads, the cause of the defeat was perceived to be arrogance and imperiousness.

The four BJP veterans who retired after Modi’s sweep in the general elections in 2014 were former Deputy Prime Minister L.K. Advani, former HRD Minister Murli Manohar Joshi, former Finance Minister Yashwant Sinha and former Consumer Affairs Minister Shanta Kumar. “To say that everyone is responsible for the defeat in Bihar is to ensure that no one is held responsible,” said the statement signed by Sinha on behalf of the others. “The principal reason for the latest defeat is the way the party has been ‘emasculated’ in the last year.” (The “latest” defeat refers to the showing by the newly-formed Aam Aadmi Party, which captured the state of Delhi that the BJP was also supposed to win.)

But the criticism by the elders has taken the wind out of the opposition’s sails. They were planning to go aggressively at Modi during the coming winter session of parliament. Instead, Modi’s own party has done it for them. Was this planned? It is singular that Modi visited Advani to “seek his blessings” a few days before the five-phase Bihar polls came to an end. The ostensible reason: It was the veteran’s 89^th birthday.

Deals in the UK

The next day, according to the media, the BJP moved into damage-control mode. Finance Minister Arun Jaitley had to fill in for Modi because the prime minister was globetrotting again, this time to visit the United Kingdom and to attend the G20 meeting in Turkey. Deals worth $13.7 billion were signed during the UK trip. However, this pales in comparison to the $61.9 billion investment by China (including several billion for three nuclear power plants to be set up in Britain) announced during the visit of Chinese President Xi Jinping in October. Modi was welcomed by a 60,000-strong crowd of mainly ethnic Indians at Wembley Stadium in London. There were fireworks here, too—literally.

Meanwhile, party loyalists who took the acrimony at face value—not everybody believes that Modi and his lieutenant, party chief Amit Shah, are capable of devious thinking—dashed off their own letter. Union ministers and former party presidents Rajnath Singh, Venkaiah Naidu and Nitin Gadkari wrote: “The party won the Lok Sabha elections last year under the leadership of Narendra Modi. Thereafter, the party had success in the assembly elections of Jharkhand, Haryana, Maharashtra and Jammu and Kashmir. The results of Delhi and Bihar have been adverse … The party would certainly welcome any guidance and suggestions from our seniors in this regard.”

It is not as though the BJP has become bogged down in this house cleaning to forget about its economic reforms initiative. “Bihar is a wake-up call for Modi,” says Baba Prasad, visiting professor of management at the Indian Institute of Information Technology in Hyderabad and a fellow at the Wharton Financial Institutions Center.

Two days after the Bihar results, Jaitley announced a spate of new reforms. Foreign Direct Investment (FDI) was to be made easier in 15 sectors, including retail, defense, construction, banking and electronic media. The key difference is that portfolio investors can now take the automatic route instead of having to apply to the Foreign Investment Promotion Board (FIPB) in each instance involving the crossing of a specified ceiling. Nirmala Sitharaman, minister of state for finance, explains that this process was always available on a case-by-case basis. What the government has done is to eliminate red tape. It is well-known that once the bureaucracy gets into the picture, delays are inevitable. The relaxation in 15 sectors is in line with the Modi government’s promise to focus on the ease of doing business.

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Not everybody agrees that there have really been true reforms or that the initiatives are good for India. “I think what is being touted as reforms by the Modi government is questionable,” says Mirza Asmer Beg, professor of political science at the Aligarh Muslim University. “Most of what is being called reforms are primarily measures that facilitate investment from capitalists in the country and outside.”

But the believers kept their faith. Jaitley promised more reforms to follow. Modi, for his part, kept the flag flying at Wembley. “We want to balance the two FDIs: Foreign Direct Investment and First Develop India … Whether it’s the World Bank or the International Monetary Fund [IMF], they all say India is the fastest-growing economy. All rating agencies show positive feedback on India’s economic growth.”

Strictly speaking, that’s not correct. Moody’s has just come out with a report warning that unless Modi steps in to control members of the BJP, India runs the risk of losing domestic and global credibility. The prime minister’s office dismissed it as the work of a junior analyst belonging to Moody’s Analytics and not that of Moody’s at all. But the organization is standing by the report.

Reaction of Foreign Investors

But what is the general reaction of foreign investors and rating agencies? Fitch Ratings said that though the Bihar defeat will complicate politics, it is unlikely to have any impact on the government’s economic agenda. The IMF says the reforms in India are moving in the right direction.

Ravi Aron, professor at the Carey Business School at Johns Hopkins University in Baltimore, goes into the impact of the Bihar loss in greater detail. “There are three different categories of impact that need to be considered: policy regime; economic behavior of states; and the resulting imbalances in state-level economic outcomes.

“For the policy regime as it applies to policies that go against entrenched interests, the impact will be indirect,” Aron says. As examples of policies that threaten these interests, Aron cites the pending bills on a goods and services tax and land acquisition. These bills are stuck in the upper house where the ruling party lacks a majority and the Bihar loss will further diminish their share of Rajya Sabha votes. “Even if the NDA had won in Bihar, the ruling party and its allies would not have a majority in the upper house. So the incremental impact of this loss is not direct,” Aron notes.

However, he adds, the loss may not be insignificant. “The regional populists and parties representing some combination of feudal and caste interests might see two takeaways from this election: First, that economic reform is politically unpopular. Second, appealing to the power of entrenched sectarian and ethnic groups is a winning gambit if you can stitch together a coalition that has enough of an electoral mass,” Aron says.

The Bihar results might change the way elections are fought in India. Coalitions are currently the order of the day. This has also been so in the past, but now the coalitions are composed of several parties of near-equal strength. “That is a good thing,” says Jayati Ghosh, professor of economics at Jawaharlal Nehru University. Aron adds, “Parties in states that are likely to go to the polls in the near future—Assam, Tamil Nadu, Kerala and West Bengal—may well take their cues from the Grand Alliance.”

Shinzo Abe and Narendra Modi / Flickr

Beg disagrees. “Such alliances are not easy,” he says. “Every state has different dynamics. In the Lok Sabha elections in which BJP got a thumping majority, it got around 30%-35% of the votes—that is their core vote base. If, from the rest, around 45% come together, then you cannot match that. So in Bihar, it wasn’t that the BJP performed badly, it was that the others got together and ensured they were defeated.”

At the end of the day, what were the issues, shorn of the rhetoric, all about? Prasad says, “It is a vote for development-driven politics. The Bihar people evaluated the BJP on the sluggish progress of economic reforms, which paled in comparison to what Nitish Kumar (the chief minister of Bihar) had achieved in his ten years as CM (chief minister). The message from Bihar is that the voting public is looking for economic progress and not for traditional caste, religion or region based politics. The loosening up of FDI policies in 15 sectors is an indication of that.” The pace of reforms, he believes, will only become faster.

Need for Political Bargains

“The government may need to strike political bargains with powerful regional parties to pass legislation or let the states determine their own policy regimes,” says Aron. “Crucial labor reforms, especially to the Industrial Disputes Act, will probably not happen. Infrastructure in some states will improve and attract value-added manufacturing.” But he adds that “the backwaters of India—the BIMARU [Bihar, Madhya Pradesh, Rajasthan and Uttar Pradesh] states, West Bengal and the geographically-remote northeast—will see very slow manufacturing growth. We are seeing growth in highly capital intensive manufacturing in India while labor-intensive manufacturing continues to languish.”

According to Aron, “The trifecta of very poor infrastructure in the factors of production, in the logistics of delivery, and extremely inflexible labor laws, has resulted in very poor levels of job creation.” The electorate in India wants good, manufacturing jobs, but does not want reforms, he notes. “Many states will not support rationalizing labor laws, land acquisition for infrastructure and privatization of unprofitable enterprises. The result is that those states that improve their infrastructure (including education and public health) will continue to grow while others fall behind. This may well be India’s ‘two-state solution’ to the problem of economic growth.”

Ghosh notes that it is already evident that the government will continue to pursue reforms designed to attract foreign capital, like the easing of caps in various critical sectors including banking that was announced recently. “However, there has been no emphasis on reforms that actually benefit the Indian economy or the Indian people, and the PM does not show any indications that he has plans to regenerate growth other than waiting for private capital to come and invest, which is unlikely in the current scenario,” Ghosh says. “If the Bihar results force the central government to focus more on inclusive growth, that would help. But so far it is not clear that this will happen.”

Nor is Ghosh particularly enthused by Modi’s global successes in Silicon Valley or at Wembley. “The Modi government has actually worsened ties with neighboring countries in the recent past. The situation in Nepal has been greatly mishandled, relations with Pakistan must have deteriorated considerably after the incendiary and appalling statements made by Modi and Amit Shah during the Bihar campaign, there are serious concerns about links with Bangladesh,” he says. “Most of Modi’s external relations are directed at visiting countries where he was earlier denied a visa, and doing world tours focused on photo-ops with leaders and ego-tripping sessions with non-resident Indians. Very little genuine foreign policy work has been done.”

One leading indicator has given mixed signals. In a knee-jerk reaction, the markets dropped 150 points plus the day after the results were announced. The Bombay Stock Exchange Sensex spent the rest of the week in the doghouse only to recover during Muhurat (the Indian New Year) trading a few days later. “In our view, the market has been excessively focused on reforms,” says a Bank of America-Merrill Lynch report. “It is lending rate cuts that hold the key to cyclical recovery.” And, after a long time, Reserve Bank of India (RBI) Governor Raghuram Rajan seems to be amenable to doing so.

India has already underperformed the MSCI (Morgan Stanley Capital International) Emerging Market index by 3-4% over the past few weeks. The Standard & Poor’s (S&P) BSE Sensex has plunged nearly 7% in the past year. The only direction for the markets—India is one of the fastest-growing large economies in the world—to go is up. Corporate earnings have been dismal recently. But bottom lines are expected to be brighter next year.

The market belongs to the bulls. But political scientists tend to be more bearish. Ghosh says, “Thus far, Modi has shown complete arrogance and intolerance of dissent.” Beg adds, “Modi seems to be more concerned with issues that are peripheral as far the governance of a developing country like India is concerned. He appears to be prime minister of rich India and of the diaspora. There doesn’t seem to be anything in the economic reforms to benefit the common man and poor people.”

*[This article was originally published by Knowledge@Wharton, a partner institution of Fair Observer.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

Photo Credit: Republic of Korea / Narendra Modi / Chokchai Suksatavonraphan / Shutterstock.com

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