As Indians go to the polls in the coming weeks, they will be voting on whether to enable Prime Minister Narendra Modi to continue his ambitious economic reform program of the largest democracy on Earth. Unlike China’s authoritarian Xi Jinping, whose economy has been expanding at a slower rate than India’s—indeed China is in the throes of a secular growth decline—during Modi’s first term, he helped engineer India to become in 2018 one of the world’s top three fastest growing economies.  Today, the International Monetary Fund (IMF) forecasts India to exhibit even higher growth in the coming years.

While that achievement should be reason enough for Indians to support Modi’s stay in office, the divisiveness that has been characteristic of the subcontinent’s political fabric has been weighing down Modi’s prospects to win a second the race. As luck would have it, however,  recent trade policy attacks on India by U.S. President Donald Trump could well provide Mr. Modi with just the ammunition he needs to mollify his opponents.

Modern economic history around the world is replete with examples where robust reformers confront intensified political challenges as their programs begin to take hold. Modi is no exception to that rule.  The structural policies he put in place during his first term are now engendering pain—most notably enlarged unemployment—before they’re able to substantially deliver their transformational gains.  The result is Modi’s poll numbers are slipping.  Populations rarely vote on ‘present value’ terms—the economists’ notion that down-payments made today are needed to enable even larger payoffs in the future.

Worse still for Modi is that in contrast to the political dynamics in 2014, when his Bharatiya Janata Party (BJP) was able to win an outright majority, today the numerous opposition parties that fractured back then, now appear to be coalescing.

The temptation for politicians in such circumstances is to veer towards a more populist stance even if it runs against the grain of their platform. Modi is certainly imbued with a populistic streak.  But, overall, his policies have achieved a comparatively balanced market-oriented approach. That strategy has been one of the secrets of his success.

Financial markets and investors—both in India and abroad—would not look kindly on Modi if he were to now shift far to the left for political expediency.  And they should. Why?  Because there is little question that India has experienced a high annual growth rate in real GDP during the time Modi has been in office.  Growth rose from 6.4% in 2013 to 8.2% in 2015; dipped to 7.1% in 2016 and further to 6.7% in 2017, but rebounded to 7.3% in 2018. For 2019, the IMF projects India will grow 7.5%, and in 2020 grow at 7.7%.

To be sure, this performance has been driven, in part, by a slower pace of monetary tightening than previously expected due to the easing of India’s inflation pressures. At the same time, India has benefitted from relatively low world oil prices; after all, the country imports about 80% of its crude oil needs.

But what has been an even more important driver of India’s growth is the confidence Modi’s reforms have inspired in domestic and foreign economic players. It’s true that there’s nothing like investor confidence to drive an economy.

The data on foreign investment show this to be the case for India.  In absolute terms, India’s foreign direct investment (FDI) inflows rose from US$27 billion in 2010 to US$40 billion in 2017, a 48% increase. (By contrast, FDI inflows to China fell 31% over the same period: from US$244 billion in 2010 to US$168 billion in 2017).  Taking into account the size of India’s economy, FDI inflows as a share of GDP in 2017 was 1.54%. (China’s FDI inflows as a share of GDP was 1.38% in 2017 and the comparable statistic for the U.S. is 1.83%.)

Modi has made no secret of the fact that he’s intent on overhauling a supremely complex, multi-layered, ossified economy—a direct result of the fact that, apart from the early 1990s, in our lifetimes, India has been subjected to comparatively limited systematic microeconomic reform of its real sector.  To this end, Modi and his economic team have made some clever policy moves since coming to office.  They’ve developed a blueprint of domestic reforms that if well-executed could arguably begin to finally fundamentally modernize the Indian economy.

But realistically this is a big “if”, especially in light of a slothy, shadowy and highly protectionist parliament in Delhi that is decades out of date with today’s global economy. And, it is the Parliament which with Modi will have to deal to get reform legislation passed. In truth, it is also the case there is skepticism about the extent of Modi’s own belief in the power of market incentives to drive and sustain needed domestic reforms within the rubric of his “Make in India” banner.

The number of reforms implemented by Modi is sizeable. While not all are breathtaking, it would be unreasonable to not be impressed with what has been accomplished to date.  Some of the more notable reforms include:

(i) enacting a revised law on bankruptcy to facilitate freer flows of capital and the flexibility for them to be invested in their highest value in use;

(ii) introducing a nationwide sales tax to integrate an otherwise excessively complicated disparate system of different state and federal taxes;

(iii) eliminating subsidies for diesel fuel to help plug a fiscal hole and more importantly create disincentives for using an energy source that adds to pollution—a severe problem in Indian cities;

(iv) removing regulations that forced companies to repetitively renew their business licenses at an artificially high frequency;

(v) relaxing rules that reserved specific sectors to SMEs even if large firms could produce the goods or deliver the services at lower cost and create economies of scale; and

(vi)  opening investment in the railway network to majority foreign ownership.

Without question, the most widely publicized reform that Modi has implemented—and for which he has been criticized most heavily—is the decision to take out of circulation large bank notes.  The measure was announced with little warning, and once executed, caused havoc in local markets around the country.  Modi’s team did do a poor job explaining the rationale for the measure in a way that the working and middle class might understand.  But to be frank, if experience in other countries is any guide–including the U.S.–that can be an elusive goal.

The reform did exact costs.  But these costs had to be faced sooner or later.  Any way you cut it, there would be a backlash.  In fact, most economists would agree that the longer a needed reform is put off into the future, the costs of reform will get only larger and larger.  And no matter when the reform takes place, the benefits would not come immediately, and moreover, they would be diffused economy-wide.

Modi’s announce rationale for this move was to reduce opportunities for corruption (which largely come about through informal cash exchanges). But the real driver behind Modi’s re-monetization policy was broader:  he is intent on moving the subcontinent to become a market characterized by economic integration and uniformity, and ideally increasingly cashless.

These are exactly the critical planks under which a geographically huge country such as India can not only begin to build economic clusters that have the scale to reduce production costs, but also to foster vibrant internal trade among India’s 29 states and 7 union territories and ultimately enhance the country’s competitiveness in the world marketplace.  The economic history of the U.S. building its large internal economic space is clearly in Modi’s mind.

Of course, this does not mean that more reforms by Modi could have been implemented.  Indeed, by all accounts he is intent on doing much more.

However, with his poll numbers currently softening, he is on a knife’s edge as to how to secure the opportunity from Indian voters to be able to continue his work.  Will he now be forced to turn his policies into a more populist direction in the remaining period before the election?  Luckily for Modi, manna does seem to have fallen from heaven.

Against the backdrop of already strong trade tensions with the U.S.—primarily over U.S. steel and aluminum imports from India and Washington’s tightening of H1 visas; and Delhi’s requirements for foreign firms to use domestic payment networks and Indian tariffs on Harley Davidson motorcycles and whiskey—on March 4^th, U.S. President Trump’s announced the U.S. would unilaterally hike tariffs on Indian imports by demoting India from the favorable treatment the U.S. has accorded it under Washington’s Generalized System of Preferences (GSP) program.  This may have given Mr. Modi just the gift he needed to obviate making a concocted campaign pivot.  Indeed, despite the obvious convenience of using Trump as a scapegoat, Modi would be wise not go overboard on this score and refrain from making substantive protectionist policies in retaliation for the proposed GSP change.

Why?  Because most of India’s exports to the U.S. fall outside of GSP, and those where it does pertain, are low value Indian goods that account for less than US$200 million per year—hardly significant compared to the US$127 billion of annual Indian-US trade flows.  Moreover, GSP is not a reciprocal program under the WTO, and thus Modi would have no legal basis on which to retaliate against the U.S.   Indian workers, businesses and consumers would see through this tactic. Worse, the U.S. will likely urge them on. Thus, any move by Modi on this score will likely backfire.

But if Modi is as clever as he seems, he won’t go down this road.  After all, such a change in trade policy would jeopardize India’s growth trajectory. Modi will not want to risk that.  Instead, he would be wise to just judiciously turn up the rhetoric for campaign purposes.  That’s just the kind of strategy that could earn him another term in office.

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