Why Modi 3.0 needs a new economic blueprint

Writing in Mint recently, Nitin Pai, co-founder of public policy think tank Takshashila Institution, said India needs to create 20 million jobs a year to gainfully employ its people. It is not that the Indian economy, which is growing at a rapid pace, is not creating jobs; the unemployment rate for people aged 15 years or above dipped to 3.1% in 2023 from 4.2% in 2021, according to the Periodic Labour Force Survey’s data. But the economy doesn’t seem to be creating enough jobs in line with demand, according to some observers.

Did this issue cost the BJP its majority and force it to form a coalition government? It may well have. According to the World Inequality Lab, the gap between the haves and have-nots has widened during the last decade, through the two terms of the NDA government. The richest 1% of the population now owns 40% of the country’s wealth. Worse, the bottom 50% own just 6.4% of the wealth.

There are variations even among the middle classes. It is unusual to see car makers growing faster than two-wheeler makers in a developing country like India. But that is what happened in the years following the pandemic, epitomizing the skewed, K-shaped consumption in key parts of the economy as inequality exploded.

However, many experts are of the opinion that the NDA government’s economic management has delivered. Indeed, BJP leaders take pride in claiming that the growth in the last nine years has pulled 248 million people out of multi-dimensional poverty.

By investing heavily in capital expenditure, economists say, the government has laid the foundation for sustained and fast-paced economic growth. Spending on welfare schemes, though significant, has been tightened and delivery is better, while subsidies are better directed, they argue. Most of all, there is a belief that the formalization of the economy has gathered pace thanks to the Goods and Services Tax (GST) and that the philosophy of ‘less government, more governance’ has begun to take root. The divestment of loss-making Air India is cited as a case in point here.

The richest 1% of the population now owns 40% of the country’s wealth. Worse, the bottom 50% own just 6.4% of the wealth.

But the electoral outcome has raised questions over the efficacy of this economic approach. While the pundits were touting the country’s strong economic growth and India becoming the fastest growing large economy in the world, the electorate had little interest in macro-level numbers. The message from the micro level—down on the ground—was clear: More than welfare, people want jobs—good jobs that pay more than the minimum wage.

Simply put, the mandate has made it clear that the government needs to tweak its policies and ensure that India’s economic growth is more equitable and broad-based. And so, as Prime Minister Modi commences his record-equalling third term, sans an outright majority, the NDA government’s economic management needs to be modified.

Sustaining Growth

Without growth, equity will be a distant dream. Without equity, growth cannot be sustained,” says C. Rangarajan, former governor of the Reserve Bank of India and former chairman of the Prime Minister’s Economic Advisory Council. India, at the moment, has got the first part right, say experts, noting that it is growing at a pace that is the envy of other large economies. In 2023-24, it clocked GDP (gross domestic product) growth of 8.2% on top of the strong 7% growth in 2022-23.

Data shows that India’s growth has been powered predominantly by the government’s massive capital expenditure (capex) post-covid. In 2018-19, the central government’s capex was just ₹3 trillion, or 1.6% of GDP. As per the 2024-25 interim budget, it will be ₹11.11 trillion, or 3.4% of GDP. A revival in exports (merchandise exports touched a new peak in FY23) and private consumption, though skewed, accelerated economic growth.

Modi 3.0’s immediate priority will be to sustain this pace of growth and that is not going to be easy. “The 8.2% growth registered in 2023-24 is a flash in the pan and cannot be maintained. An average 7% GDP growth would be ideal,” says Rangarajan. In 2024-25, it may slip further.

Madhavi Arora, lead economist at Emkay Global Financial Services, estimates India’s economic growth will fall to 6.5%.

“Slowing manufacturing, a not-too-exciting consumption story, where private consumption growth is the lowest in 20 years excluding the pandemic years, a high base effect and cyclical headwinds are the contributing factors,” she explains. The cyclical headwinds include slowing exports, tighter lending standards and commodity prices no longer being low.

Reform Limitations

While economists have called for the next generation of reforms to accelerate economic growth, the compulsions of coalition politics could limit such ambitions. “Big-factor market reforms like land, labour, agriculture and capital could take a backseat. So will privatization and asset monetization,” says Arora.

Instead of wasting its energy on big-ticket reforms that are difficult to pull off in a coalition era, economists say Modi 3.0 should restrain its impulses and focus on less contentious but more effective policies.

“There are a lot of reforms that can be executed to provide wings to the economy. Coalition partners will have no issues with them,” says Sunil Kumar Sinha, senior director and principal economist, India Ratings.

These include financial sector reforms, judiciary-related changes, improving the dispute settlement mechanism, which can free up a lot of locked-up capital, and so on, says Sinha.

Growth with Equity

G. Sundaramurthy, a 42-year-old native of Pollachi in Tamil Nadu, was happy working in one of the many small-scale industrial units in nearby Coimbatore. Lack of formal education prevented him from getting a formal job in one of the large industrial units that dot the city. In the last five years, he has changed jobs multiple times as the units he worked in were forced to shut or downsize their operations. Sundaramurthy, in other words, is a victim of the formalization of the economy.

“In India, the formal sector has never created the jobs that the economy needs. Typically, it is the unorganized sector that did this,” says Sinha. In agriculture, 92% of the jobs are created in the unorganized sector. In industry and services, 73% of the jobs that are created are informal. The government and private sector account for only 27% of the jobs, notes Sinha.

The BJP government strongly believed in organizing the informal sector and such a move, it felt, would go a long way in plugging the leaks in tax mobilization and contribute to economic growth. Policymakers either did not factor in the impact of formalization on job creation or assumed the expanded formal economy would create the necessary jobs. A series of measures by the government, such as demonetization and the introduction of GST, left the informal sector reeling, leaving small entrepreneurs and workers like Sundaramurthy in the lurch. The covid pandemic only served to exacerbate the situation.

In India, the formal sector has never created the jobs that the economy needs
—Sunil Kumar Sinha

“Between 2017-18 and 2022-23, the footprint of the unorganized sector in the gross output of the economy fell by almost two percentage points, from 34.9% to 33%,” points out Sinha. Some jobs may have disappeared. “The organized sector, to some extent, filled the vacuum left by the informal sector, but it never created that many jobs,” he says. In fact, he argues, the formal sector, which is driven by cost competitiveness, can never create as many jobs as the unorganized sector. Its focus has been and will be to increase productivity by reducing labour per output unit.

While formalization of the informal sector is the way forward as it leads to better quality jobs, where workers will get better pay and social security, a labour surplus market such as India should make the transition (from unorganized to formal) in a measured manner, especially at a time when a large number of youth are entering the workforce, say experts. Having rushed through this process, India appears to be struggling.

Government officials that Mint spoke to, who did not want to be identified, accepted that this is a problem. The only way to correct this situation is to strike a balance, say economists. “The informal sector should also be supported in a big way. The government has come up with Mudra Loans and a few other schemes, but they have not been enough. Much more needs to be done,” said one economist.

Fiscal Consolidation

Another facet of the NDA government’s economic management is its penchant for fiscal consolidation. Prior to the pandemic, the government had brought the fiscal deficit down to 3.4% of GDP, the closest in years to the target of 3% set under the Fiscal Responsibility and Budget Management Act way back in 2003. Covid put paid to any plans for a further reduction.

The fiscal deficit ran up to 9.2% in 2022-21. The Modi government brought it down to 5.8% in 2023-24 with a plan to reduce it to 5.1% by 2024-25. This has been possible partly due to revenue buoyancy and more importantly, due to aggressive reduction of unwanted revenue expenditure and better targeting of welfare schemes and subsidies. “Ten years ago, the revenue expense as a proportion of total expenditure was 89%. In 2024-25, it will be just 77%,” says Emkay’s Arora.

Would the electoral outcome have perhaps been different if the government had eased up on fiscal consolidation and spent more on people struggling at the bottom of the pyramid? Sixty-three-year-old M. Ayyanar, from Andipatti, a town in South-West Tamil Nadu, certainly thinks so. He is trying hard to sell the cucumbers grown on his small farm outside the town’s bus stand. Ayyanar plies an autorickshaw, but the Tamil Nadu government’s decision to offer free bus rides to women has hurt his business significantly. He barely makes money to cover his fuel costs and is deep in debt, having borrowed money to fund his daughter’s marriage and pay for the education of his son, who remains unemployed. “I agree there are many welfare schemes, and they help my family immensely. But we are still struggling to lead a decent life,” he says.

Sathyanarayana Rao, G. Sundaramurthy and M. Ayyanar are the faces of India’s rural distress. Modi 3.0 will have to keep them front and centre in framing its economic policies. Fortunately, the government has the fiscal headroom for spending more. The Reserve Bank of India has just given it a ₹2.1 trillion dividend bonanza, equivalent to 0.4% of GDP. Will the government go for it? Its first budget next month will offer a clue.