Creating the Indian Arc of Industry

With the election of the Narendra Modi-led Bharatiya Janata Party (BJP) government in May 2014, one important question is asked with remarkable consistency—“Can Modi’s development record in Gujarat be replicated nationally?” Most people take this to be a polar question—either “yes” or “no.” The reality is likely to be somewhere in between. There will be a stronger emphasis on the economy, greater direction in policymaking, and faster decision-making. India will not be completely transformed overnight, or even within five years. But the business environment will improve quite a bit. The biggest transformation is likely to occur in a critical “Arc of Industry,” an important block of states in western and central India that will likely be controlled by the BJP and allies, and which contain key productive assets.  

The Need to Industrialize

Manufacturing makes up only about 13 percent of the Indian economy, and has declined in recent years—it was as high as 17 percent in 1996. This is quite low compared to other emerging markets against which India competes for investment. The percent of GDP from manufacturing in China is 32 percent; Korea - 31 percent; Indonesia - 24 percent; Malaysia - 24 percent; and Thailand - 33 percent.
 
India’s relatively low levels of education, a shortage of skilled workers, and rapid urbanization have resulted in potentially explosive levels of urban under-employment. Creating industrial jobs has become a national imperative.
 
In addition to its economic/demographic challenge, India has an extremely high trade deficit in goods at around $139 billion in 2013-14, or about 8 percent of GDP. Trade with China accounts for nearly $40 billion of this trade deficit. Notably, even while India’s overall deficit fell from $190 billion the year before, its deficit with China remained the same. India’s trade deficit adds new pressure in India to create a stronger industrial sector. The Congress-led United Progressive Alliance (UPA) government was unable to pursue difficult policy changes needed to create a supportive environment for manufacturing. Ultimately, the UPA government chose to force a range of industries to begin manufacturing locally.
 
The Modi government has made infrastructure development and manufacturing the two main (and related) priorities at the outset of its five year term. The global business community would like to see India succeed in creating a supportive environment in which foreign firms are not forced to localize when it does not make commercial sense. But there are important constraints on the Modi government’s ability to adopt and implement economic policy reforms.
 
Limitations on Modi’s Influence

While investors cheered when the BJP won a majority of seats in the lower house of India’s Parliament, or Lok Sabha, there are several reasons why the BJP will still have an uphill battle reshaping the economy. The BJP is quite weak in the Rajya Sabha (upper house of Parliament), holding only around 18 percent of the seats—a fact that is unlikely to change dramatically until late in Prime Minister Modi’s term. There are important fiscal constraints that will preclude the types of tax concessions Prime Minister Modi had offered investors during his tenure as chief minister of Gujarat. A third factor that will limit Prime Minister Modi’s influence across India is the nation’s federal system of governance.  India’s 29 state leaders exert much more influence on a citizen’s day-to-day affairs than the central government, and the BJP only controls five of these 29 states.
 
Looking more deeply at this federal system—most people think of the April-May 2014 Parliament election as the “BJP election,” but in fact many regional parties which run their own states also had record-setting returns in the Parliament election. Examples include the Tamil Nadu-based AIADMK (37 seats, up from 9 seats in 2009), the West Bengal-based Trinamool Congress (34 seats, up from 19 seats), the Odisha-based Biju Janata Dal (20 seats, up from 14 seats), the Telangana-based Telangana Rashtra Samithi Party (11 seats, up from 2 seats), and the Andhra Pradesh-based Telugu Desam Party (16 seats, up from 6 seats). As in any democratic society, these regional parties see their own mandates strengthened, and will not feel beholden to a more powerful BJP.
 
What is “Reform” to Modi?
 
In order to estimate Prime Minister Modi’s impact on the economy, we need to review what his style of “reform” entails.  As evidenced by his tenure as the chief minister of Gujarat, as well as statements made since winning the national election, the Modi government will focus on building infrastructure to create a stronger manufacturing base. And to build infrastructure, there needs to be a strong center-state alignment—something which may not be feasible when dealing with sometimes-difficult regional leaders that do not like to be seen showing fealty to New Delhi.
 
So the “Modi influence” will be strongest in states controlled by the BJP, with some influence as well in states controlled by coalition allies.  As noted previously, the BJP is currently in control of only five of India’s 29 states - Chhattisgarh, Goa, Gujarat, Madhya Pradesh, and Rajasthan. Coalition allies control another three states - Punjab, Andhra Pradesh, and Telangana. This means that the “Modi influence” is limited to only eight of India’s 29 states. Congress, on the other hand, currently controls 11 states—more than double the BJP’s total.
 
Why the Arc of Industry

However, we can also look ahead to upcoming state elections to see how the BJP’s footprint in state governments may change. By the end of 2014, Maharashtra, Haryana, Jharkhand, and Jammu & Kashmir will hold elections. Delhi may very well have another election, too, later this year. The BJP is not the incumbent in any of these states but, together with its allies, won at least half of the Lok Sabha seats from every one of these states in the recent Parliament election (41 of 48 Parliament seats in Maharashtra, 7 of 10 in Haryana, 12 of 14 in Jharkhand, 3 of 6 in Jammu & Kashmir, and 7 of 7 in Delhi). So it stands to reason that the BJP has an excellent shot at winning four or five more states within the next year. This likely scenario (outlined in Figure 1) expands the scope for center-state alignment in carrying out sensible economic policies, including infrastructure development.

 
Figure 1.

In addition to expanding the number of states it controls, this group of states has another important feature—they are contiguous. This fact is critical in order for the Modi government to carry out its plans to become a stronger industrial nation. Transit of production goods from region to region is much more important in manufacturing than in services, so ensuring that transportation infrastructure is developed in tandem across connected regions will help sew the subcontinent together. Instead of looking at Indian states as mid-sized countries with imposing border controls, foreign investors would be better positioned to tap into India’s massive population and key urban markets.
 
A third reason this Arc of Industry is poised to become the hub of India’s industrialization is that it includes some of the country’s most important productive assets. The highlight in this regard is the 1,483 km Delhi-Mumbai Industrial Corridor (DMIC), a mix of dedicated freight rail, industrial townships, modernized airports, highways, and ports. The vast majority of the DMIC lies in states that are, or likely will be, controlled by the BJP by the end of 2014. China’s industrial development was initially quite regionally-focused, so there is precedence with another very large nation using this model to accelerate economic activity. There are also key ports, airports, LNG terminals, and other productive assets already in place, or under development in this particular region.
 
Can this Arc of Industry Become a Reality?

Additional reforms, such as creating a national Goods and Services Tax (GST), will expand the scope of what can be achieved through the creation of this regional hub. It will also be important to watch how state leaders outside this hub view its progress- will they want to participate as a way to modernize their own economies, or will they want to remain outside the orbit of the national government?  For India to make dramatic progress on her national goals of increasing employment and reducing poverty, other large states like Uttar Pradesh, Bihar, Tamil Nadu, and West Bengal must be included. Otherwise regional disparities will only increase.
 
Many of the industrial projects necessary to create this regional hub are already underway. If Modi’s track record in Gujarat is any indication, we can expect timelier execution of big infrastructure projects. Irrespective of whether other states get on board, momentum appears to be on the Modi government’s side in making this Arc of Industry a reality.

Richard M. Rossow is a senior fellow and holds the Wadhwani Chair in U.S.-India Policy Studies at the Center for Strategic and International Studies (CSIS) in Washington, D.C.

This Commentary originally appeared in APEC Currents, a newsletter published by the Australian APEC Study Centre (AASC) at RMIT University. This piece also complements an earlier video presentation produced by CSIS on India’s Arc of Industry, which can be viewed here.

This Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

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