More than a lick of paint needed

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APOLLO TYRES started life in 1972, but a milestone for the firm came two decades later, in 1991, when it completed a huge factory in Limda, near the industrial city of Vadodora in Gujarat state. It was a notable year for India because, in the face of mounting economic crisis, the finance minister of the day, Manmohan Singh, took the first steps in a momentous budget to throw off the shackles of bureaucracy, protectionism and state-dominated business that had held India back for so long.

The economy fizzed, and with it Apollo Tyres. Its factory has twice been extended since. The most recent addition in 2009 was inaugurated by Narendra Modi, then Gujarat’s chief minister, now India’s prime minister. A framed photograph of Mr Modi adorns the factory entrance.

Disappointment about India’s prospects set in with a vengeance not long after the photo was taken. Mr Singh, who became prime minister in 2004, lost his reform mojo and growth slowed; then, a couple of years ago, the Indian economy flirted with another balance-of-payments crisis, when India’s currency and stockmarket dived.

How different the mood is today. Apollo is just the kind of company that India’s boosters are proud of: its four Indian plants not only produce for a booming domestic car industry, but export 1m passenger-car tyres a year to Europe. Jumbo tyres for monster mining vehicles are made to order in the newest part of the Limda plant. Yet enthusiasm for India’s prospects runs broader. Textile operators are rushing to set up factories in Tiruppur in Tamil Nadu, India’s “knitwear capital”. Japan’s heavy-industry giants are enthused again about a planned Delhi-Mumbai industrial “corridor”, which has official Japanese backing. America’s General Motors is exporting Indian-made cars to South America. And everywhere brokers and investment bankers are rating India a “buy” once more.

In part the optimism is due to a recovery that is not shared by other big emerging economies, notably Russia and Brazil. India is benefiting hugely from a worldwide slump in energy prices. Consumer-price inflation has halved, to 5.1%. The current-account deficit has shrunk. And the rupee has been stable (see charts). Official statistics show that GDP grew by 7.5% year-on-year in the last quarter of 2014. Though that figure has been “improved” by statistical tinkering, the economy is more stable than it has been for years.

The optimism has also to do with Mr Modi himself. His Bharatiya Janata Party (BJP) won a thumping victory in India’s general election last May in big part because of his business-friendly record as chief minister of Gujarat, and because he promised to transform the daily lives of 1.25 billion Indians.

And yet. For all the renewed cheer, most Indians face a formidable set of challenges before their lives can be transformed. For all of Apollo’s success as a large manufacturer, its kind are notable exceptions in India. Most Indians still earn hardscrabble livings in the countryside. Many who escape farm work for the cities make a living not in regular employment but in informal services or small-scale manufacturing, where productivity and wages are low. Successful companies face huge obstacles and much red tape. Electricity is unpredictable. Air and water are massively polluted. And infrastructure—from roads to ports to power stations—is woefully inadequate.

On February 28th Mr Modi, through his finance minister, Arun Jaitley, can send a powerful message both to Indians and foreign investors that his government means change. It is when Mr Jaitley presents the government’s first full budget. Used cleverly, it could serve as a clear signal of the Modi government’s intentions in the months and years ahead. For Indians’ sake, it should aim to be as transformational as Mr Singh’s was in 1991. Whether it will astonish or not is less clear.

Making your own breeze

To give the government credit, it has created some of the fair wind behind it now. At the origin of India’s slump earlier this decade was a sharp fall in investment. Big projects, such as power plants and roads, became snarled up in red tape. Huge corruption scandals broke in 2011 surrounding the transfer of mining rights and mobile-phone licences to private companies. That made civil servants cautious about granting permits and licences lest they also be accused of graft.

Another constraint was inflation fuelled by cheap money and fiscal stimulus. The economy overheated, and as inflation climbed, Indians rushed into gold, a popular store of value. Surging imports of gold pushed up the current-account deficit to alarming levels. The mix of a fiscal deficit, a gaping current account and inflation caused a sharp fall in the rupee in 2013 as foreign capital fled.

The old government and the central bank, the Reserve Bank of India (RBI), took steps to get India back on track. Mr Modi has taken a few more. In his early weeks in power he lit a rocket under the bureaucracy (though he is still said to be aghast at the resistance, listlessness and lack of capacity he has met among even senior civil servants). A backlog of applications for business licences began to shrink.

A decision by the Supreme Court in September to cancel 214 coal-mining licences granted between 1993 and 2010, because of corruption surrounding their issuance, introduced huge uncertainty. But a new regime of auctioning replacement licences began this month. Leading indicators of capital spending, such as lorry sales, are slowly picking up. The RBI, under the leadership of its able governor, Raghuram Rajan, has met its target of getting inflation below 8% by the start of this year—a commitment that helped to calm financial markets and stabilise the currency. It is now confident enough of meeting a second goal of bringing inflation below 6% by 2016 that in January it cut interest rates for the first time in two years. Further reductions are likely.

The central bank has several remaining challenges. The biggest is that India’s public-sector banks are so weighed down by dud loans from the last investment boom that they will be unable to finance the next one. The RBI says that, from the beginning of April, loans that have had their terms rejigged will be treated as if they are bad loans: banks will have to set aside 15% of the loans’ value as a precaution. The deadline ought to encourage banks and debtors to agree on how to share losses. A resolution to the bad-debt problem would eventually free up the worst-affected borrowers—mostly power and infrastructure firms—to start new projects.

In addition, India’s state banks may need up to $85 billion to meet international rules on capital and to cover losses on bad debts. That cannot all come from the government. Mr Jaitley has said he will allow private investors to hold up to 48% of state banks’ shares. But new shares cannot be sold at a good price unless he can convince investors that banks will be run free of political interference. One proposal is that the state’s ownership of banks should be rolled up into an arms-length holding company.

Taking the giant steps

Mr Jaitley must signal reform appetite in other areas, too. A vital one is companies’ ease of doing business, on which the World Bank ranks India 142nd in the world. The government has made a start, with ordinances in December that make it easier to acquire land for development. Separately, there are plans for a single portal through which new businesses can apply for all the permits needed from various government departments. The government has blessed a move by Rajasthan to loosen its labour laws by declaring that its liberalisation trumps archaic national laws. And given India’s appalling reputation for imposing arbitrary taxes on companies, it is encouraging that the government has not appealed against a recent court judgment to do with tax in favour of big multinationals.

Another crucial area is to push forward plans for a national goods-and-services tax (GST). Such a tax is critical, for two reasons. First, it is the best way for the central government to increase taxes as a share of GDP. Its abysmally low current share is a huge constraint on policymaking. Second, a GST would also replace a welter of state taxes and other levies that serve, in effect, as protectionist barriers, impeding a true internal market in India. The government recently tabled a bill to establish a GST, possibly the single biggest reform it could make. But such a tax has been discussed for years. Now the government has to make it happen.

Elsewhere, the groundwork for bolder reforms is in place. A switch from subsidies, such as those on fuel and food, to cash benefits for the needy would cut waste and save money. As little as half of public spending on welfare reaches its intended recipients, according to the McKinsey Global Institute. Half of the subsidised grain set aside for the poor either turns bad in transit or ends up being sold on the open market. On top of this are the costs of implicit subsidies. Politicians often bully regulators to cap electricity prices, causing losses among generators. The result is power shortages.

A system for cash transfers is being set up. The government says that more than 125m no-frills bank accounts, linked to biometric identity cards, have been opened for ordinary Indians. Two-thirds of the new accounts remain unused. But Mr Jaitley says that 330 billion rupees ($5.3 billion) in transfer payments and wages from a rural employment scheme will soon flow into them. Another potential route is banking using mobile phones. India’s big mobile operators have rushed to apply for a new sort of banking licence.

Still bolder moves will be needed if Indians are to enjoy sharply higher living standards. Skill levels remain an obstacle to many sorts of work. Almost 70% of India’s working-age population have no education past primary school. Their best hope of escaping low-wage farm work is low- to mid-skilled jobs in factories, shops, hotels or restaurants. Yet India’s regulations put a cap on firm size. Four-fifths of the jobs in Indian manufacturing are in firms employing fewer than 50 workers. Firms that want to grow bigger have problems dealing with fiddly regulations, buying land, securing power and working around India’s baffling labour laws.

These are big issues for Mr Jaitley to take on. At the least he needs to signal an intention to carry out well-sequenced reforms to raise growth and create jobs. The doubt is whether he is able to do so. Last July Mr Jaitley’s stopgap budget was a timid affair. He is, in truth, an old parliamentary operator rather than a bold reformer.

The prime minister’s office is said to be guiding chunks of the budget—no bad thing. But in the coming months the government must also get legislation passed, national tax reform above all. It will mean persuading states—BJP-led ones almost as much as those, such as West Bengal, run by fierce opponents—to strike a deal at last on tax. If this parliamentary session achieves as little as the ones to date under Mr Modi, then he will have found that, so far as his domestic agenda is concerned, the first of five years has already slipped away.

Even the most successful businesses retain an air of healthy scepticism. Why should Apollo, which is putting up a brand-new factory in Hungary, not build a new factory in India? “A new greenfield investment is a question-mark,” says the firm’s boss, Neeraj Kanwar. “Let’s see what happens in the next two years.”

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