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Children play in the streets of a resettlement community for survivors of anti-Muslim violence that tore through Gujarat in 2002 on the outskirts of Ahmedabad, the state’s largest city. (IAIN MARLOW/THE GLOBE AND MAIL)
Children play in the streets of a resettlement community for survivors of anti-Muslim violence that tore through Gujarat in 2002 on the outskirts of Ahmedabad, the state’s largest city. (IAIN MARLOW/THE GLOBE AND MAIL)

Subcontinent stagnation: How India botched its economic miracle Add to ...

Jaswant Singh has very little in common with Indian billionaires like Ratan Tata.

He runs a small roadside shop that sells candies to school children and spends his nights in a small, cramped house in the north Indian city of Varanasi with his wife, his daughter and 14 other members of his extended family. His business isn’t doing that well, either: Mr. Singh holds up a container of pink sweets and explains that every time he goes to buy more in bulk, the prices have gone up. “It is very difficult to survive,” he says, running his hand through his black sidepart.

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But despite circumstances many Indians frustrated by the country’s stagnating economy can understand, Mr. Singh’s opinions on India’s ongoing national elections are remarkably similar to those of the country’s business class and wealthy elite.

Like them, he desperately wants Narendra Modi to win.

Mr. Singh says the ruling Indian National Congress Party has mismanaged the economy and become corrupted. Behind a counter at his tiny roadside shop in Uttar Pradesh, a poor state with 200 million people, he says he looks west to the prosperous state of Gujarat where he sees in Mr. Modi’s 12-year reign as the state’s chief minister the sort of uncorrupted, stable, pro-business leadership that India now desperately needs at the national level.

“We’ve seen what Congress has done with the economy,” says Mr. Singh, his stubble-covered jaw set in a grimace. “We are going for Modi. We saw what Modi did in Gujarat. We are hopeful. Everybody is depending on him.”

Throughout India’s six-week election process, which concludes on May 16, Mr. Modi has coasted on a broad wave of dissatisfaction with the country’s deflating economy. In just a few years, India has gone from an emerging-market powerhouse with blistering growth to a stagnant mess of stalled economic reforms, haphazard regulation and rampant corruption that have helped rob the country of its enormous promise and kept many of its citizens in poverty. Reviving India’s botched economic miracle is now the key motivating factor for voters in elections that could radically alter the course of the world’s largest democracy and second most populous country.

Most polls suggest the controversial Mr. Modi and his right-leaning, Hindu nationalist Bharatiya Janata Party (BJP) are heading to a historic victory over the National Congress Party, which has ruled almost uninterrupted since India’s independence from Britain. If they win, Mr. Modi’s rise will have come about because of the economy’s decline.

“This is the first election where the economy matters,” says Shailesh Pathak, president of corporate strategy at Srei Infrastructure Finance Ltd., an Indian firm listed on the London Stock Exchange. “And that’s what Modi is playing to.”

Hangup at Vodafone

Andre Jerome once took a call from a panicked Indian employee who had a gun held to his head.

The corporate lawyer from Quebec was the general counsel for Vodafone Group PLC’s Indian operations, and a staff lawyer in the poor and occasionally lawless northeastern part of the country was on the phone, surrounded by criminals. They wanted official company letterhead in order to write themselves phony references.

“It’s crisis management,” Mr. Jerome says about doing business in India. “It’s really crisis management, all the time.”

Mr. Jerome first suggested calling the police, but the lawyer said the man holding the gun was the local police chief’s brother-in-law. Mr. Jerome told his employee to hand over whatever they wanted.

But Mr. Jerome refused to follow his own advice when he received a rather alarming letter from the Indian tax authority.

Vodafone had bought its way into the Indian market with an $11-billion (U.S.) acquisition of a large cellphone provider owned by Hong Kong-based Hutchison Whampoa Ltd. The purchase came through a Cayman Islands-based firm that, however legal, left the company open to political attacks. A few weeks after Mr. Jerome arrived, he received a letter from the Indian tax authority demanding Vodafone pay a sum that eventually swelled to around $5-billion.

The global firm quickly became Exhibit A for India’s rapidly deteriorating investment climate.

Mr. Jerome battled through India’s court system, brushed off various requests for bribes, and eventually secured a positive Supreme Court verdict in 2012. But he was flabbergasted when the Congress-led government, two months after the top court’s ruling, introduced retroactive amendments to the country’s tax law that would allow the government to again pursue Vodafone over the funds – a move that led U.K. Chancellor of the Exchequer, George Osborne, to say it was hurting India’s international reputation. And Vodafone was far from the only foreign company facing a tax dispute: Nokia PLC was also slapped with a demand, and companies such as Morgan Stanley and IBM also ended up in tax disputes.

But for Vodafone, which now has around 160 million subscribers in India, the tax dispute was simply the most sensational and longest lasting of the firm’s many struggles – which span the breadth of India’s myriad challenges.

For a while, Vodafone and other companies saw the wireless industry paralyzed by one of India’s many recent corruption scandals. The telecommunications ministry was accused of selling wireless licences at a steep discount, costing the exchequer an estimated loss of $40-billion. The telecom minister was imprisoned for more than a year and several mid-level executives and other politicians ended up in court.

Soon after that auction, in which many companies bought licences planning to flip them at a profit, the government introduced a new rule saying companies couldn’t sell licences for three years, but would be penalized if they didn’t build a network. That ushered in an era of unsustainable price wars as some markets saw more than a dozen competitors. At one point, in a fit of economic nationalism prompted by concerns over Chinese competition, the government suggested new import quotas that emphasized the use of local telecom equipment – an industry India does not possess. Importing any individual foreign part would require government approval, and with more than 100,000 cellphone towers scattered across the country, Vodafone’s Mr. Jerome said this would have amounted to more than 5,000 requests per month from his company alone. The government soon relented.

And even though Vodafone was adding nearly three million customers a month at its peak, an obscure regulatory decision that lowered so-called “interconnection rates” had the effect of cutting per-minute revenue from each customer by 50 per cent over the course of a year. At one point, Mr. Jerome found himself discussing India’s business difficulties while golfing with CEOs from a big European sporting retailer, a U.K.-based energy firm and a high-tech company.

“It was just incredible that India was perceived as this place of growth and economic development, but none of us were making any money in India, and wouldn’t for the foreseeable future, except for the energy guy,” says Mr. Jerome, who has since left the company. “Once you’re in, there’s so many of these issues.

Economy choked

What’s happened to India’s economy, suggests Mr. Pathak of Srei Infrastructure, is like someone driving a car at 80 miles an hour and then lifting their foot off the gas pedal and coasting to a standstill.

After the National Congress Party introduced landmark economic reforms in 1991 that dismantled the so-called “Licence Raj,” the Indian economy began to soar. The BJP took power in 1998 and ruled until 2004, further liberalizing various sectors of the economy such as telecom, and launching a national highway building program, he says. They also appointed cabinet ministers that he says were capable and informed and kept growth going. But since 2004, when the Congress-led United Progressive Alliance (UPA) coalition took over, he says growth was taken for granted.

India’s red-hot GDP growth has indeed slowed dramatically. From highs of 11.4 per cent GDP growth in 2010, the rate withered to 6 per cent in 2011 and remained well below 5 per cent throughout 2013 and 2014. Things got worse as the U.S. Federal Reserve tapered its bond-buying stimulus, which sucked money out of many emerging markets, including India. The rupee fell sharply and the Reserve Bank of India raised interest rates repeatedly, chilling the climate for new investment in badly needed infrastructure – such as roads – that could boost growth. At the same time, rising costs for staples such as onions have stung poorer Indians.

Part of the economic stagnation lies with policy paralysis in the central government. Economic reforms have stalled before Parliament. The Environment Ministry has frequently refused to approve certain projects. And as various corruption scandals engulfed the government – under poor cabinet appointments that Mr. Pathak says were based on politics – bureaucrats began sitting on key files, refusing to approve projects or issue permits on the off chance these deals were corrupt and they would get arrested.

“If they don’t take a decision, then they can’t be charged,” says Arvind Panagariya, a professor at Columbia University. “And if you do, you can be. And this paralysis became widespread.”

The total value of stalled projects is currently estimated at more than $10-billion, according to London-based research firm Capital Economics.

As things got worse, many prominent Indian companies – which were going global anyway – began to vote with their wallets, investing overseas rather than in India. In the depths of India’s telecom sector scandal, Bharti Airtel spent $9-billion to buy Zain Group’s wireless properties in 15 African countries.

In 2012, India’s coal sector was rocked by a $34-billion scandal that once again revealed the extent to which politicians siphon cash out of licence-reliant industries regardless of the impact on India’s citizens. At the same time, restrictive, unreformed labour laws continue to prevent the expansion of India’s tiny manufacturing sector, where owners are uncomfortable hiring in good times because firing in bad times is so onerous. Large welfare schemes were expanded, despite their often corrupt and inefficient administration.

Over coffee at a hotel restaurant in New Delhi, Mr. Pathak breaks out more analogies to describe India. “Our states are larger than most European countries,” he says. “We have our Germanies. And we have our Greeces.”

Land-locked Uttar Pradesh, for example, has 200 million people and is generally quite poor – an example of an Indian Greece. Coastal Gujarat, though, where Mr. Modi has been chief minister, has more than 60 million people and a strong economy – a sort of Indian Germany, with roughly the same population as the U.K.

He then turns his attention to the table, which keeps rocking despite a napkin placed under the leg. “And this is a bit like the UPA government,” he says, referring to the Congress-led coalition, as he rocks the table back and forth with a laugh.

A model state?

Many contrast economic policy paralysis at the national level with what’s happened in the state of Gujarat under the leadership of Mr. Modi.

Many business people hope that with momentum on his party’s side, the BJP will seize power and orchestrate the type of economic reforms that occurred under the earlier BJP government. But in some ways, that will depend on the number of seats the BJP and its coalition partners win. What the business establishment realistically hopes for is that Mr. Modi brings to the central government the type of predictable, pro-business leadership he showed through more than a decade ruling Gujarat, where his government won successive majorities.

Although Gujarat has long been an export-oriented trading hub, with a renowned business class, local business people say Mr. Modi has had a profound influence on the way the state operates – and in attracting business. Most famously, Mr. Tata, the revered chairman emeritus of the Tata Group conglomerate, received a personal SMS text from Mr. Modi when he was having difficulties erecting a factory in the state of West Bengal. The business titan ended up bringing his factory to Gujarat.

“You’re stupid if you’re not here,” Mr. Tata told a crowd at the Vibrant Gujarat investment summit, a meeting that Canada has co-sponsored more than once. “This state is one of the most progressive states in the country ... It has a government that works.”

Over a decade in power, Mr. Modi has launched road-building initiatives, built a rapid bus network, constructed irrigation systems for farmers, and dramatically improved the power grid by threatening to jail those caught stealing electricity. He is famous for his decisiveness and for following up with bureaucrats to ensure they’re actually working. Unlike at the national level, the approval process in Gujarat has become streamlined. “They’re giving clearances, and not having people going from ministry to ministry, begging for approvals,” says Dinesh Kanabar, deputy CEO of KPMG India, who worked with Mr. Modi on Vibrant Gujarat.

He gives cabinet ministers broad mandates and expects them to perform, but although he does not let them appear often in public, he supports them when there is pushback. “People think he’s a dictator,” says Saurabh Patel, a cabinet minister in Mr. Modi’s government who is responsible for energy and mines. “He just expects people to stick to the policies and systems ... He makes people work.”

Mr. Modi is well known for being a harsh taskmaster, but local business people in particular remember him not just for ramming through change, but for specific kindnesses.

Ajay Goenka, the chairman of Rainbow Papers Ltd., a large paper company listed on the Bombay Stock Exchange, has met Mr. Modi many times. He once lobbied the chief minister to change Gujarat state government procurement restrictions that prohibited departments and agencies from buying local, Gujarat-made paper. Mr. Goenka received a letter that evening informing him that it was done. In a country where approvals can take months, or hefty bribes, this was remarkable. “In other states, it would have cost us time and money both,” Mr. Goenka says, noting that local businesses regularly bribed officials before Mr. Modi took office.

Among Indian business people, Mr. Modi is revered with a fervour bordering worship. Mr. Goenka, who once gave Mr. Modi a copy of a Ripley’s Believe it or Not book as a gift and received a signed thank you note in return, recalls a telling meeting. Mr. Goenka says: “One industrialist just said ‘I want to touch him.’ ”

Divisive leadership

Mr. Modi, of course, is also well known for his polarizing politics, stoking Hindu-Muslim tensions and leaning heavily on a record of economic development that many critics think is burnished and distorted. He has become broadly popular because of the state of the national economy, but the situation in his home state – partly because of his own reliance on his track record – has haunted him during the campaign.

In 2002, anti-Muslim violence flared across his state, leaving more than 1,000 people dead – most of them Muslims. Many police officers did nothing. And some in Mr. Modi’s administration were implicated. Since the violence, human rights groups have had to fight Mr. Modi’s regime for compensation and housing, since many buildings and mosques were torched. At one point, Mr. Modi referred to the Muslim resettlement communities in Gujarat as “baby-making factories,” but as he has run nationally, he has toned down that sort of rhetoric – although one of Mr. Modi’s close confidantes was recently warned by the Election Commission of India after exhorting Hindus to get “revenge” against Muslims by voting for the BJP.

For these reasons, many see Mr. Modi – who rose through a hard-line, Hindu nationalist organization – as an unfit leader for such a diverse country. Nandan Nilekani, the billionaire foudner of Infosys and a candidate for the rival Congress party in tech-centric Bangalore, says Mr. Modi is a divisive, dictatorial leader.

“I think running India is very different from running a state,” Mr. Nilekani says in an interview. “Running India is managing the complexity of different parts of the country. Different religions. Different language groups. Different castes. Different ethnic groups. It requires a very broadminded and very consensus-oriented leader.”

But Mr. Modi’s rise on economic credentials have led to a critical re-examination of his state’s development. Despite strong growth and the opening of facilities from firms such as McCain and Bombardier, Gujarat still trails other states such as Tamil Nadu in terms of both economic growth and foreign direct investment.

The state has also regressed on some social metrics during Mr. Modi’s time in office: Malnutrition remains high, the state’s literacy ranking has fallen, the ratio that measures female infanticide has gotten worse, and the percentage of state funds spent on health has declined.

Gujarat has not been immune to India’s tragic, debt-prompted farmer suicides. Critics view Mr. Modi’s wooing of investment with incentives and land allotments as unsustainable giveaways that do not generate well-paying jobs for the masses. Indian liberals and many academics see Mr. Modi’s economic track record as a sham – and his success perplexes and frustrates them.

Still, Gujarat remains one of India’s top-performing states, at a time when the national economy is faltering. And although Mr. Modi and his party are not immune to putting politics before free markets – on issues such as foreign investment in the retail sector – polls suggest that Indians see him and the BJP as the ones to fix the current economic mess. But if he does come into power, fixes – if coalition politics allow them – won’t be instant.

Reverting to his car analogy, Mr. Pathak says India’s business class is not expecting too much. “He’ll put the car back in first gear,” he says. “Then second. That’s more than enough for us. We don’t expect miracles.”

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