Only the bookies, who offered even money on the return of Manmohan Singh as prime minister, seem to have gotten it right. The results of India’s general elections confounded psephologists, pundits and political parties alike. A fractured mandate was expected. In the end, the Congress-led United Progressive Alliance (UPA) won hands-down.

According to the final tally, the UPA has close to 260 seats, with Congress itself tallying up more than 200, its highest score in 18 years. The midway mark in Parliament is 272 seats. With some UPA partners and independents ready to add their numbers, a workable simple majority is assured. Most important, the Left, which had been the former government’s ball and chain, has been reduced to half its strength, and a much smaller fraction of its importance. The stalled reform process can go full-speed ahead.

Wharton management professor Jitendra Singh says “the most positive aspect” of the election results is that “there will be no need to get in bed with ‘partners’ like the Left, whose behavior has been consistently obstructionist [and] negative overall.” He sees “a good opportunity” for the prime minister to usher in “long-awaited reforms” in sectors like insurance and labor laws, allow foreign investment in universities, and step up infrastructure investments to catch up with China. “India really needs to put infrastructure on the front burner,” says Singh, who is just back from a China trip and was struck by “the superb quality of the airports and highways leading from the airports to the cities.”

Saikat Chaudhuri, also a Wharton management professor, agrees that with the Left parties now contained, the government will find it “much easier” to introduce reforms. However, he points to what he calls a “paradox,” where the Left was “a very big obstacle to development” at the central level, but was “very proactive and pro-private investment” at the state level. Overall, however, he expects increased government stability, “which bodes well for … privatization of state enterprises and labor and pension reforms.”

Ravi Aron, a senior fellow at Wharton’s Mack Center for Technological Innovation, agrees with Wharton’s Singh about the need for reforming labor laws. He believes the Singh administration should “allow firms the flexibility to lay off blue-collar workers (manufacturing labor). That provision exists for the white-collar labor force. Without this, there will be no rapid growth in manufacturing employment in India. Firms will simply not scale up their manufacturing labor force without this flexibility.”

Manmohan Singh has already swung into action. Says the morning daily Indian Express: “As the (Congress) party made it clear that allies will not be allowed to arm-twist the government, an assertive PM called a meeting of his officials and directed them to prepare a blueprint for ‘quick action’ in the first 100 days of the new government. The PM’s message, conveyed to officials by principal secretary T.K.A. Nair, was clear: ‘Hit the ground running’ in the second term. Priorities will include a comprehensive 100-day plan for internal security, countering global recession with focus on job creation, (and) infrastructure investment, besides expansion of social sector programs.”

“The first 100 days are going to be crucial for the new government,” says Sunil Bhandare, economic and government policy adviser to Tata Strategic Management Group (TSMG). “To begin with, in the first 30 days itself, the government must prepare a white paper on the impact of the global economic crisis on the Indian economy. The white paper needs to clearly communicate the current status. Following this, the (Union) budget needs to have a very powerful stance and direction on what the government proposes to do.”

‘US$700 Billion Worth of Investments’

The elections’ outcome “will usher a new wave of confidence globally in the Indian economy, with more than US$700 billion worth of investments to be channeled into India’s infrastructure, power, telecom and pharma sectors over the next five years,” says Bundeep Singh Rangar, chairman of IndusView Advisors, an India-focused cross-border advisory firm. “This will provide the country a strong foundation to achieve the aspirational growth of 10%.”

With such widespread ambitions, much needs to be done on the economic front. The prime minister knows this well — and the worldwide economic crisis is adding to the pressure to set the government’s business agenda.

In an email poll conducted prior to the close of the elections, India Knowledge at Wharton readers listed education, infrastructure development, health care reform and energy security as the top areas that need action. Other suggestions ran the gamut and included foreign policy, agricultural reforms, corruption and economic inequities. On employment generation, one reader called for incentives for companies to create jobs “where skills/capabilities reside … to train and employ local talent … and discourage migration to overcrowded urban centers.” Another said, “No more ‘We will do whatever the U.S. says’ attitude,” while yet another noted that the government should consider disinvesting in public sector companies a top business priority.

Grappling with the slowdown is obviously foremost on most citizens’ minds. But opinion is divided on whether the country needs another economic stimulus. There have been three already — on December 7, 2008, and January 2, 2009, plus an across-the-board cut in excise duties and service tax announced on February 24. “The packages were too mild to provide a significant boost to the sagging economy,” says Chennai-based daily The Hindu. Others say it is too early to expect results. “The immediate need for further fiscal stimulus does not appear to be that acute,” says Rajesh Chakrabarti, assistant professor of finance at the Hyderabad-based Indian School of Business (ISB).

By some parameters, the situation remains grim. The index of industrial production fell 2.3% in March compared with March 2008. That was the most in 16 years. India’s exports in April were down by a third from April 2008, and imports dropped by 35%. All this can make for dismal reading. Yet on the day these data were announced, the Bombay Stock Exchange Sensitive Index (Sensex) spurted 475 points, or 4.07%.

The government already had acted to stimulate the economy. But once the country went into election mode it was unable to take fresh steps, as that would have violated the Election Commission’s code of ethics. With the government out of action, it was left for the Reserve Bank of India (RBI) to cut interest rates by a quarter point at the end of April. This was meant to spur growth; bankers say room exists for further cuts.

But the elections, even if they hobbled the government for a time, have provided their own impetus. The Delhi-based Center for Media Studies estimates that election spending totaled more than US$2 billion. Another study, by Kotak Institutional Equities, the secondary market broking operations of the Kotak group, puts spending at US$3.38 billion, bringing in a stimulus of US$5 billion, or 0.5% of GDP. Of course, all political parties have made lavish promises to win votes. If these are implemented, the ratio of gross fiscal deficit to GDP could increase by 1 to 2.4 percentage points, Kotak says. That could be a disaster in waiting.

‘Signs Point toward Recovery’

Yet the picture is looking better than it has for months. According to a Confederation of Indian Industry (CII) survey, the Indian economy shows “nascent signs of recovery.” The CII business confidence index improved by 2.4 points to 58.7 for the first half (April-September 2009) of the current fiscal year. The ABN AMRO Bank purchasing managers’ index, based on a survey of 500 companies, stood at 53.3 in April. It had been 49.5 in March. An index level above 50 signals expansion. Meanwhile, the Sensex has recovered nearly 80% from its low of 8,047 on March 6, reaching 13,736 as of May 21.

“Right now, the signs point toward recovery,” says Chakrabarti, of ISB. “It is still not clear whether this recovery is sustainable, but the immediate need of further fiscal stimulus does not appear to be that acute. Such broad-based stimuli pose medium- and long-term fiscal management issues, so a stimulus is probably necessary only if the situation reverses toward further deterioration. Sector-specific steps like relief for textiles or (small and midsize enterprises) may be more useful.”

There are no free lunches, of course. Spend on a stimulus package and you add to the fiscal deficit. “Fiscal discipline has gone haywire with reckless deficit spending over the past two years on burgeoning subsidies, farm-loan waivers, and huge increases in the salaries and pensions of government employees following the Sixth Pay Commission recommendations,” The Hindu says. “To meet the unprecedented growth in expenditure, the government has resorted to huge borrowings.”

India’s fiscal deficit is estimated to be among the highest in the world at more than 10% of GDP in the last fiscal year and around 12% in this one. It is not likely to come down over the next few years, owing to the expected increase in spending. Says Rangar of IndusView: “India’s fiscal deficit during April-December last year jumped to US$44.5 billion as the government stepped up spending to stimulate the slowing economy. The government’s borrowing program will also rise to a budget estimate of US$65 billion in 2009-10 from US$28 billion in 2008-09, and will likely remain at elevated levels.”

“The fiscal deficit will be the primary concern in the medium term,” says Chakrabarti of ISB. “The difficulty of the task will hinge upon the actual growth rate and tax collections. It is likely that the government will try to get out of a tight corner here by using the funds from disinvestment.”

Ashvin Parekh, national leader, financial services, for Ernst & Young (E&Y), however, says the deficit need not be a top priority. “Even the developed economies are going to report substantial fiscal deficits,” he says. “So India will draw solace from that. With inflation at the sub-1% level, there will be no immediate pressure on the new government to focus on the fiscal deficit.”

The Role of Disinvestment

One way to bridge the gap — disinvestment of public-sector undertakings (PSUs) — has to move to center stage. According to the Congress manifesto, “Indian people have every right to own part of the shares of public-sector companies while the government retains the majority shareholding.” The last government had to go slow because of objections from the Left. In fact, the Union Ministry of Disinvestments was converted into a Finance Ministry department and sidelined. The wheel could turn full circle now.

“PSU disinvestment may make much-needed funds available to government to get the fisc back in order,” says Chakrabarti of ISB. “The sooner it begins, the better. However, the mood of the markets itself would be a factor in determining the exact timing. On the other hand, disinvestment may help cheer markets as well.”

“The disinvestment program must be brought back,” adds Bhandare of TSMG. “It provides some extra physical space by way of mobilizing revenues. It creates a favorable impact on the equity market, and the infusion of shareholders’ money introduces a higher degree of accountability. On all these counts — both economic reasoning and ideological considerations –disinvestment of PSUs is absolutely essential.” Parekh of Ernst & Young says a disinvestment program should not be a return to the earlier approach. “The performance of the PSUs has changed dramatically since the time the last disinvestment policy was drawn up,” he says. “There is need for a completely fresh look at PSU disinvestments. The earlier policy is completely outdated.”

PSU disinvestment is a key component of financial sector reforms. And this sector will garner considerable attention. But, given the environment, don’t expect sea change overnight. “Our approach to financial sector reforms has been gradual, consistent and constant. … You cannot take risks in a low-income country,” says RBI deputy governor Rakesh Mohan, who has just resigned to take an assignment at Stanford University. In banking, in particular, there is no crying need for action. True, the center is recapitalizing some public-sector banks. But this isn’t driven by the crisis. It’s a conservative approach to maintaining the banks’ capital adequacy above international and RBI norms. Foreign banks, meanwhile, are keeping silent about reforms. They want to get their house in order first.

In some areas, however, things are happening. A new pension scheme was launched May 1. It essentially extends to the private sector and the self-employed an earlier scheme that applied to government employees. “The new pension system is easily the most important pension reform in the world today,” says The Economic Times. “It targets a pension coverage gap that is larger than the populations of most countries.”

But this is just a beginning. In insurance, much was expected of the UPA government after it threw off the yoke of Left support in the wake of the Indo-U.S. nuclear deal. The Union cabinet had approved a bill, which allowed foreign companies to raise their holdings in Indian insurance joint ventures from 26% to 49%. But the bill was never passed in Parliament. The insurance industry in India is around US$30 billion today, according to estimates by the Associated Chambers of Commerce and Industry, and will rise to US$60 billion by 2012. This will require a considerable infusion of funds, and the Indian partners of joint ventures are finding it difficult to pony up their share. The sector will receive a boost if insurers are allowed to sell off another chunk of their stakes to their foreign partners. Almost all the global insurance majors already have a presence in India.

A reconsideration of foreign direct investment norms may be imminent, and not just in the financial sector. Some changes were ushered in early this year, but they lacked clarity. Now, one could see higher foreign stakes being allowed in areas such as retail and telecom — and, of course, insurance. Wharton’s Singh notes that India has become a more attractive destination than it was earlier for foreign direct investments, although China will continue to be ahead in this area.

“In the financial sector we need two sets of reforms,” says Parekh of Ernst & Young. “One is around instruments in the marketplace. We need to really expand the base. In banking, I expect reforms to see a setback. The pressure from the global banking system to make India open up its banking system will reduce. In insurance, the government needs to give the regulators far more enabling powers.”

No Quick Fix for Exports

One area crying for help is exports, where job losses have begun to pinch. India’s exports declined for the seventh consecutive month in April, to US$10.7 billion compared with US$16.07 billion in April 2008. Imports fell from US$24.82 billion to US$16 billion. An original export target for 2008-09 of US$200 billion was scaled down to US$175 billion. That, too, is unlikely to be achieved.

The Indian export sector directly and indirectly employs 150 million people. According to the Federation of Indian Export Organizations, the slump will result in a loss of 10 million jobs. Exports are expected to pick up only in September.

But quick-fix solutions are difficult to find. “There will doubtless be a clamor for more support for exports,” says Chakrabarti of ISB. “But, given the world situation, the government’s ability to affect exports materially may be limited.” Bhandare of TSMG offers a medium-term perspective: “The new government needs to strengthen the SEZ (special economic zone) framework and support the serious players in the SEZs, especially in the multi-product SEZs. There is also a great need for reduction of procedural complexities.”

Aron notes that companies that “export services from India — BPO and ITO firms — have to make up for the failure of the state in providing the physical infrastructure and business infrastructure” — ranging from power shortages, through deficiencies in urban infrastructure and transportation to labor laws and inflexible rules and regulations associated with doing business, which can raise the cost of operations by between 5.2% to 11.9%. “Many of these companies provide everything from door-to-door transportation to medical facilities for their employees in order to keep their operations running smoothly.”

Relaxation of labor laws is another consideration. “It’s a real hornet’s nest that the government has not gotten to as yet,” Wharton’s Singh says. Owners of unprofitable companies must have the opportunity to shutter them with more ease than they have now, and the flexibility to lay off employees in such situations. “Let the government take charge of retraining and redeploy [laid-off workers] in other areas,” he advises.

Addressing the labor issue “is absolutely essential for sustained long-term growth and employment,” says Chakrabarti of ISB. “However, we have to understand that this is also arguably the most complex part of the reform process, with too many vested interests. Things are unlikely to flow very smoothly on this front.” Anticipate change, therefore, but don’t hold your breath.

Another area that will demand attention, if only for public consumption, is agriculture and rural development. Rural India has done well the last few years, boosted by five successful monsoons. While industry has slumped, agriculture has helped GDP maintain its 5%-plus growth, which is the most pessimistic estimate for 2008-09.

“Agriculture and the rural economy need to be given the right kind of projections and preference,” says Bhandare of TSMG. “India has not been so adversely impacted by the current global crisis because the rural economy has been able to sustain some degree of momentum. This needs to be sustained. The government must prepare a clear crop-wise production program in consultation with the state governments. All the rural programs like the NREGS (National Rural Employment Guarantee Scheme) must be further strengthened and enlarged to every single district. Rural infrastructure needs to be a strong focus area.”

It’s not just rural infrastructure that demands attention. The government needs to find the money — no easy job in this environment — to spend on infrastructure across the country. “The government needs to implement the 11th [five-year] plan targets, which now look remote because of the crisis and the paucity of investment funds,” says Chakrabarti of ISB. “The 11th plan envisaged a strong public-private component. The government may be fund-starved to do too much on its own unless private funds are forthcoming.” Adds Bhandare of TSMG: “The new government must also ensure that the public-private participation framework is strengthened by creating the institutional framework for center-state coordination, financial closure, and viability gap funding. Simultaneously, the government also needs to strengthen the bond markets for long-term financing.” He says some homework has been done. “The focus needs to be on the implementation strategy in the infrastructure sector. The policies, the basic framework in most sectors are in place. What is required is the implementation methodology.”

Not everyone agrees, however, on what must come first. Parekh of Ernst & Young summarizes the debate by suggesting that everything needs to be looked at with a fresh eye. “With new protectionist moves and new trade measures coming from the developed economies, the definition of right and wrong is getting challenged,” he says. The environment has changed. The government has changed. So, too, could the economic agenda.

Power generation should be another key priority, according to Aron. “India faces huge power shortages. In 2007, at peak demand the shortfall was nearly 15%…. India plans to increase its power output by 90,000 MW annually. Compare this with China — it added 100,000 MW in 2007. In 2007, India added 7,000 MW. Private investors could be tapped — but they fear that SEBs (State Electricity Boards) would give the power away to farmers for free or permit it to be stolen. To attract private funding, it is necessary to separate generation, transmission and distribution. But several states resist this since this will limit their ability to give power away for free to farmers.”

Energized as it is with the big election wins, the new government should steer clear of falling into a sense of complacency, warns Singh. “Most careful watchers of the global economy are bullish on the Indian economy in the long term, but we must keep reminding ourselves that growth projections are not economic reality,” he says. “Just because the recent revisions by Goldman Sachs of the growth rates of the BRIC economies [Brazil, Russia, India and China] now suggest that China and India will gain their predicted ascendancy a decade earlier than predicted does not mean that this will happen.”

Chaudhuri also advises against complacency, and calls for continued efforts to contain the influence of political forces that obstruct development. He points to the resurgence of the Trinamool Congress led by Mamata Banerjee in West Bengal, the party that built up local resistance to force the Tata Group to last year abandon plans to locate its Nano manufacturing plant in that state. Chaudhuri recalls that the Trinamool Congress had been reduced to one seat in Parliament in the 2004 elections, “was decimated” in the state assembly elections two years later, but has now rebounded, capturing 19 of the state’s 42 seats in the latest elections. “Flawed policies in land acquisitions gave an opening to the opposition” in the case of the Nano controversy, he says.

Wharton’s Singh says the Congress Party would do well to learn from the lost opportunities after its landslide win in 1984 following Indira Gandhi’s assassination. The party, led by Rajiv Gandhi at the time, had won 80% of the seats (401 out of 508 contested seats). “That would have been a good time to decide whether India should move to a presidential system from the Westminster-style of parliamentary democracy,” he says, describing the current system as “a recipe for inaction, where we get hung Parliaments.”

Opportunities to introduce bold reforms across the economy are rare, he says. “This is a time to push forward in a major way, not to lose momentum, and make the most of the proverbial ‘political sunshine.'”

Aron offers another perspective. “Which of these reforms can we see enacted in the next five years?” he asks. “Labor reforms are least likely since this is a political hot potato. We may see some half-hearted divestment in public-sector enterprises. There may be modest increases in power generation and at best the addition of a few colleges and universities. The SEBs in many states will continue to give power away for free to politically well-organized groups and thereby deter private investors as well as create shortages.”

Aron argues that in India, “there is no consensus on economic reforms. Ironically, the resistance to these reforms comes most from those who stand to benefit most from [them] — the poor and lower middle classes. India will continue to amble along the reforms road. In spite of India being the home of companies like Wipro, Tatas, Reliance and Infosys, the World Bank rates India as the world’s 122 best place in which to do business. Indian companies — the ones that achieve excellence — are locked in a struggle to overcome the frailties of the state. Their excellence is not made in India but made in spite of India.”