India's Economic Long Game

3 MINS READDec 19, 2016 | 09:15 GMT
India's Economic Long Game
Indian Prime Minister Narendra Modi wants to promote economic growth and job creation through his land, labor and tax reform bills.

India's winter parliamentary session ended without agreement on the elephant in the room: the pulling of the 500- and 1,000-rupee notes last month. Parliament also failed to pass the three remaining parts of the Goods and Services Tax (GST), a sweeping tax reform advocated by the ruling party to simplify the tax code, boost interstate trade and unite India's isolated state economies into a single national market. The two items are related: The ire and panic provoked by the demonetization scheme — 500- and 1,000-rupee notes will be worthless come the first of the year — worsened parliamentary gridlock and prevented lawmakers from coming to agreement on GST. But, angling for re-election, Indian Prime Minister Narendra Modi is unwilling to compromise on demonetization, even if it comes at a hefty economic cost.

Opposition parties — particularly the Indian National Congress and West Bengal's Trinamool Congress — blocked the legislation needed to fully pass the GST reform, demanding that Modi debate the matter in the upper house of parliament, which he declined to do. Consequently, the ruling Bharatiya Janata Party (BJP) will fail to implement the measures by its April 1 deadline. But politics is a game of trade-offs, and this setback is emblematic of the kinds of hefty short-term costs Modi is willing to absorb to promote his long-term goals, which include first making sure his party wins ample seats in 2017 parliamentary elections and second that he wins re-election in 2019.

State legislatures appoint members to India's Rajya Sabha, the upper house of parliament. If Modi wants to promote economic growth and job creation through his land, labor and tax reform bills, he needs to bolster his party's strength in that upper house. Seven states go to the polls next year, including Punjab, Goa and Modi's home state of Gujarat. The most important of all, though, is Uttar Pradesh. As India's most populous state, Uttar Pradesh is the biggest political prize, contributing 31 members to the upper house, more than any other state. It is also critical for national elections, for which Modi is already laying the groundwork, hoping for re-election. Demonetization is Modi's direct attempt to curry favor with Uttar Pradesh.

Modi made this clear during his campaign stop on Dec. 11 in Bairach, northern Uttar Pradesh. Taking aim at the two biggest parties rivaling his in the state — the Samajwadi Party and the Bahujan Samaj Party — Modi promised that his party alone could rid the state of "gangster rule" and tied demonetization to anti-corruption, development and empowering the poor, three of the guiding themes of his state-level campaign. In 2014, Modi's BJP won 71 of the 80 seats that Uttar Pradesh contributes to the lower house of parliament in national elections, and he is hoping to replicate that win in 2017 state elections, which ultimately decide the upper house.

Modi was aware that by choosing to launch demonetization when he did — Nov. 8 to be exact — he was risking the GST legislation. And he no doubt expected that any initiative as audacious as yanking 86 percent of the currency from circulation was bound to cause significant disruption, from long lines of flustered Indians stretched outside banks to small-scale gatherings in which demonstrators torched effigies of him. This, however, is a price Modi is willing to pay to win elections. By attacking the country's illegal wealth, Modi is playing populist politics, positioning himself as the champion of the poor in a country teeming with poverty — and hoping it is enough to win Uttar Pradesh.

Of course, whether his gamble pays off will only become apparent with the 2017 election outcome. In his favor, despite the widespread sense of frustration among Indians, large protests like those seen earlier this year have yet to break out. What's more, the BJP is polling at least a close second, if not first, in Uttar Pradesh. The negative economic implications of demonetization — including falling inflation and declining gross domestic product growth — have already been set in motion. But Modi hopes by suffering some pain in the short term, he will be able to overhaul India's economy in the long term.

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