05/19/2014 04:56 pm ET Updated Jul 19, 2014

Did the Economy Win India's Election?

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Narendra Modi's big election victory in India -- the first absolute majority in 30 years -- will be interpreted as a big win for the economy. Current Indian financial market effervescence similarly reflects high hopes for pro-business reforms. Reality is more sober. It would be hard for Modi to fail to improve India's economic management, but big wins, tackling the thorniest barriers to growth, remain unlikely.

The Indian economy has slowed significantly over the past three years for reasons far more troubling than a weak external environment. Government action has never been India's strength, but this appears to have become the key impediment to growth in recent years.

During the fast growth of the last decade the needs of the economy for public goods like power, roads and public administration outpaced the government's capacity to provide them. Since 2010 a weak prime minister and corruption scandals further reduced government performance. The bottleneck has become so restrictive that investment has nearly ground to a halt.

To unleash India's economic potential, the government must address a long and well-known list of reforms. Success matters for much more than regaining the glory of a double-digit growth path. It matters for job creation, for creating pathways out of poverty for hundreds of millions.

None of these reforms can be achieved without a significant political cost to Modi. This is where reality kicks in. In fact, on paper Modi's reform agenda does not differ significantly from that of the outgoing Congress Party. If these reforms were so easy to achieve, why didn't the Congress Party do them during its ten years in office?

The election resulted in three distinct improvements in the prospects for reform.
  • First, Modi owns the victory and its mandate alone. Unlike the dysfunctional Sonia Gandhi-Manmohan Singh division of authority in the last government, there is a single voice at the top.
  • Second, the new government has won strongly enough that coalition problems should vanish. Fractious coalition members tanked more than one important reform initiative of the last government.
  • Third, Modi's mandate is clearly to follow his playbook from his time as Chief Minister of Gujarat. The business-friendly, efficient and low-corruption model of government won this election.

Inevitably commentators will evoke comparisons to the 1991 wave of reforms that unleashed India's growth juggernaut. Yet today's economy -- fortunately -- bears no resemblance to the economic crisis that enabled those reforms. The Modi Wave will not benefit from such focused national desperation.

Instead, there are many reasons to think a Modi Wave will hit a sea wall. For instance, Modi's support from within his Bharatiya Janata Party (BJP) will surely weaken once his cabinet is formed and tough decisions begin. The BJP record on corruption matches that of Congress. Efforts to clean house Gujarati-style will generate strong counterattacks.

Cutting energy subsidies, an unavoidable measure to rectify fiscal accounts, is another example of a policy that will fragment Modi's supporters. This requires neither legislation nor fieldwork, so it can be easily done. As essential as this may be, it is also a surefire path to protests and unpopularity in many corners. Indeed, the BJP led many national strikes against past gasoline price hikes.

And Modi will still need to work with the opposition. India has a strong tradition of consensus decision-making. Policies that are implemented against the wishes of the opposition -- the US nuclear deal or allowing foreign direct investment in retail come to mind -- have a tendency to fall apart after passage.

In this respect, the BJP's legacy of opposing sensible reforms for the sake of political gain will hurt Modi. Despite Modi's strong victory, he does not have a majority in India's upper house of Parliament. The Congress Party will undoubtedly play the same game, throwing sand in the gears of Parliament as often as possible.

Tax reform, high on Modi's priority list, exemplifies this risk. Because the reform affects state-level taxes, state governments must accede to its passage. The BJP -- at Modi's behest, if rumors are true -- effectively organized enough resistance to prevent passage for five years. Congress controls many more states than the BJP, providing the leverage to return the favor.

The bottom line is that even with his strong mandate and concentrated political power, Modi will not have an easy time achieving goals like revitalizing manufacturing. The biggest hurdles -- labor regulation, land acquisition, inadequate infrastructure -- represent some of the most intractable problems India faces.

Modi's victory will surely accelerate the pace of reform, but that is a low bar to clear. Even a minor improvement in business confidence can generate a big boost in economic activity because industrialists are desperate for any rays of hope. But making enough reform progress to get India's economy back to full steam could easily consume Modi's entire term. If this is a win for the economy, it will not be an easy one.