India – cyclical uplift has run its course

India is nearing the first anniversary of the coming to power of the Modi-led BJP government. The SENSEX has delivered 18% return during this period (26% yoy) and the INR has withstood the whiplash of the dollar rebound. Real GDP growth has maintained its steady 5-6% (7.4% forecast for 2015) while inflation has gradually eased off from 10.9% to 6.4%. But the truth is the success of the BJP government has only gone as far as turning around the economy’s cyclical recovery – which economists from the Real Business Cycle school would argue that this would have been a natural course of event without any government support anyway. Entrenched structural problems remain unsolved.

India has over 200 political parties vs just one in China

In our “compare and contrast India to China” – which is a MUST to do because both are big countries and lie on the same continent – the biggest distinction between Asia’s two most populated nations is their political structure. For India, this is its biggest handicap while for China, this is its biggest advantage. In its 70 year old democracy, India has more than 200 political parties, most operating at the provincial levels which make passing any national law a near impossible task. The two most sticky issues now are the introduction of the GST and the “reform” of the land reform act. In contrast, China has one single party – as we all should know.

The BJP-led coalition only has control of the lower house, called the Lok Sabha, and has not been all too successful thus far this year in the state elections to garner the upper house, called the Rajya Sadha. Some may not know this – behind the BJP is the big power broker, Rashtriya Swayamvevak Sangh (RSS), somewhat like the powerful business group, Keiretsu is behind Japan’s long reining LDP. The RSS is a right-wing Hindu nationalist, purportedly non-governmental umbrella organisation with a network of schools, charities and clubs. This organization was formed in 1925, well before the country gained its independence from the British in 1947.

Rahul Gandhi making a comeback?

Meanwhile, the National Congress party is not dead – not especially for a country where voters are prone to “idol” worship – I don’t mean the religious kind, just the association of political parties to individuals rather than ideology or principles. By suddenly resurfacing from his two-month disappearing act with various versions of a spiritual healing escapade, Rahul Gandhi may just surprise everyone with a major overhaul of his great grandfather’s political party. After the party’s stunning defeat in the 2014 general election, I’m sure both Congress party elites and supporters would embrace the idea of change.

So the battle may soon restart. Congress party hopefuls are looking for Rahul Gandhi to put up a hard fight to the BJP’s proposal to “reform” the Land Act to make it easier for the government to acquire land from farmers for building infrastructure and converting to industrial land. The current act was itself a recent amendment put in place in the twilight years of the Congress-led government to favour farmers, giving them the right to drive a hard bargain from the government and requiring any land conversion from agricultural to industrial use to be subject to strict environmental studies. Since the act was amended over three years ago, virtually all infrastructure projects have come to a standstill.

So you think the GST is such a great idea?

Then there is the introduction of the GST which is intended to replace the state VAT, sales tax and wholesale tax etc. The idea is to replace all taxes currently collected by the state governments with a uniform tax to be collected by the central government which will redistribute the revenues back to the states. To this cause, the central government has assured the states that the GST will be revenue-neutral to all. Herein lies the trick. State VAT rates are currently not uniform – the highest is 14.5%, and even worse, the collection is far from uniform. To assure the states that GST will be revenue neutral, the only way is to introduce it at the “highest common denominator” which comes close to 27% according to some calculation. The idea is then to introduce it at this highest rate and gradually bring it lower to so called get it back to revenue-neutral. Now, to begin with, if state taxes are not uniform and collection is far from uniform, a 27% GST seems guaranteed to kill the economy. The target is to implement GST by next April. Although not explicitly mentioned, it’s quite clear the BJP’s desire to implement GST also carries a political motive – to gain financial control over the states, thereby increasing its political clout from the centre too.

One local market watcher is praying the GST will never ever get implemented because he sees it not only as a potential economic hell breaker but as a political suicide for Narendra Modi.