India Races to Revamp its Economy and Military

Photo: Kevin Frayer/Getty

Indian Prime Minister Narendra Modi is well known for his massive Twitter following – roughly 32 million – and obsession with taking selfies at every occasion. But it was his promise to bring the economic success and clean governance of his home state of Gujarat to the rest of India that fueled Modi’s rise to power in 2014.

This Gujarat model is the driving force behind “Modinomics,” which focuses on rooting out corruption in the government and society, slashing the regulation and red tape that strangles foreign direct investment, and kick-starting Indian manufacturing through the “Make in India” program. In November of last year, the Modi government proved just how committed it was to pursuing radical reform when it suddenly removed two of the largest currency denominations from circulation in an effort to hamstring the black economy.

So far, these efforts have met with some success. The Indian economy has been growing at an annual rate of seven percent, the government has made real progress in slashing the fiscal deficit, and Modi has launched a military reform and modernization program that is boosting spending and bolstering the domestic defense industry. However, behind these successes lie a system still riddled with corruption and inefficiency. As he works through his third year in office and faces down China in a border standoff along the Himalayas, can Modi invigorate the nascent economic and military power of India?

On the economic front, Modi’s government has made its most impressive progress on reforming India’s macroeconomic fundamentals. The fiscal deficit, which stood at 4.1 percent when Modi entered office, has fallen to 3.2 percent, almost exactly in line with the Prime Minister’s economic roadmap. Meanwhile, inflation has plummeted and India’s current account deficit has shrunk to just 0.6 percent of GDP.

However, Modi’s track record on his other major economic goals is more mixed. First, on the effort to bolster Indian manufacturing and make the country more attractive to foreign investment, Modi has managed to bring India up 12 spots in the World Bank’s Ease of Doing Business indicator. However, that only brings India to 130 out of 190 countries. On a deeper level, notes Director of the Carnegie Endowment’s South Asia Program, Milan Vaishnav, reforms to the investment environment do not mean that Modi is cleaning up India’s massive state-owned enterprise. To the contrary, says Vaishnav, “he [Modi] has been very reluctant to privatize SOEs… his government is pro-business but it also has a strongly nationalist outlook, and those two things are mutually reinforcing.”

The real question mark in Modi’s economic plan is the effect of de-monetization on the economy. The surprise ban on two bank notes, which represented some 86 percent of all currency in circulation (roughly $220 billion), gave Indians just 50 days to exchange their discontinued currency for new notes. This created chaos as people queued for days to unload their now-worthless money, and many lost their life savings. Cash-dependent sectors like agriculture have also taken a hit from the ban, and growth this year has already begun to sink below seven percent. Nevertheless, observes Vaishnav, “the political impact [of the ban] has been enormously successful for Modi… He has managed to turn this into an issue of civic duty and patriotic nationalism. Either you’re with us or you’re with the corrupt cronies who have looted the country for 70 years.”

Increased government spending has also helped to cushion some of the economic damage from the ban, and defense lies at the forefront of this splurge. Sandwiched between a hostile Pakistan and the looming power of China, India has been working to revamp and expand its military infrastructure over the past decade. The country tested its first intercontinental ballistic missile (the Agni-V) in 2012, and unveiled its first domestically built aircraft carrier (the INS Vikrant) in 2013. Since taking power, Modi has sought to build on these milestones by integrating the domestic defense industry into his “Make in India” program, commissioning new arms acquisition projects, and increasing the defense budget – by almost $4 billion this year. The 5 week-old standoff with China on the Doklam Plateau, where New Delhi has just put an additional 50,000 soldiers on alert, only enhances the urgency of these plans.

But here too, the prime minister is struggling to overcome deep institutional challenges. According to Sarah Watson, Fellow on U.S.-India Policy Studies at CSIS, the Modi government’s efforts to open the defense sector to foreign investment and cooperation have fallen far short of the mark. So much so that “FDI in the defense sector in the most recent fiscal year (ending March 2017) was an abysmal $10,000.” India’s notoriously slow and laborious acquisition process has also led to the abandonment of critical programs – including the planned purchase of 136 new air superiority fighters.

Meanwhile, bureaucratic inefficiency and financial mismanagement within the military is widespread. In the fiscal year 2015-2016, India’s Ministry of Defence spent just 87 percent of its defense equipment budget, and in 2015-2016, the Ministry missed the mark again, allocating 91 percent of it allotted budget. According to Watson, the problem is such that “even basic supplies can be scarce: in the most recent procurement scandal, a report by the Comptroller and Auditor General revealed that national stocks of 40 percent of standard ammunition types were insufficient to fight a 10-day war.”

There are signs that the Modi government is beginning to take these issues seriously and considering reforms – such as removing requirements that foreign defense firms take joint ownership with Indian partners. This is not only good news for Indian defense, it could become the lynchpin for future ties between the U.S. and India. Under the Obama Administration, the relationship with India was tied to economic and trade cooperation, with the eventual goal of stitching India into the American-led trade regime of the Trans-Pacific Partnership (TPP). Now that the Trump Administration has left the TPP and made little progress on other trade liberalization efforts, Vaishnav says that defense could become “a sector that will provide the ballast in the U.S.-India relationship.”

In short, Modi is forging ahead with his dream of driving India into the position of economic, military, and geopolitical power deserving of the world’s second most populous nation. Despite the pain of the currency ban and the deep institutional obstacles his government faces, Prime Minister Modi has retained his popular support. He will need all that political capital and more to enact the radical changes he has envisioned.

Fritz Lodge is a Middle East and international economics analyst at The Cipher Brief. Follow him on Twitter @FritzLodge.