The verdict of the recent State elections is clear – the Congress and UPA II are in trouble. Yes they involved only 73 parliamentary seats; but the standing of the Congress in the States that were not part of the election may be even worse.  Where did UPA II go wrong? I submit that the fault lies in their economic policy strategy since 2008-09.

The problem begins with their misinterpretation of their electoral success in 2009.  Influential forces within the party attributed it to the rural antipoverty programmes and saw in these a way of building up a power base for the Congress amongst the rural poor.  The possibility that the electoral success may have been because of the boom economic conditions and more jobs for young workers was discounted though it probably accounts for the continuation of Dr. Manmohan Singh as PM and his close economic advisers in their erstwhile positions.

The 2008-09 global crisis threatened economic growth and was met with a substantial fiscal stimulus.  In this lax macro environment there was a push for large rural anti-poverty schemes and later, after 2010-11 for big increases in agricultural support prices with their attendant subsidy burden.  Economic policy czars could have resisted this pressure by pointing out that the fiscal stimulus could only accommodate the burden of rising subsidies for a short period and that when the macro environment called for fiscal tightening the rising subsidy burden would become a major constraint. But they did not, perhaps from complacency given the continuation of high growth for a couple of years, and moderate inflation in the first year of the stimulus. But after 2010-11 the economic situation deteriorated rapidly with growth rates falling, double digit inflation, rising fiscal deficits and a widening of the current account deficit. Yet the subsidy largesse continued with more populist schemes despite the worsening fiscal and economic situation.

Confronted by this difficult macro and foreign balance situation the policy czars started implementing a two pronged strategy of promoting foreign investment and monetary tightening with rising interest rates and liquidity squeezes. A great deal of political capital was expended on policy changes on foreign investment, for instance for retail trade, with little effect.  This may have been based on an export pessimism in a recessionary global environment and inelasticity in imports leaving capital inflows as the only way of closing the current account gap.

Monetary tightening did little to control what was clearly a supply-side inflation and put a damper on investment. Decision making bottlenecks for environmental clearance, land acquisition, coal linkages added to these anti investment pressures.  Confronted by all this and slowing growth the corporate sector withdrew into a shell, many small units shut shop and the rate of job creation for young workers fell.

A government that was using up its political capital for promoting foreign investment and monetary stringency had to retain the support of coalition allies and that led to the tolerance of many scams which surfaced at regular intervals and used up the Manmohan Singh’s team USP of integrity and probity.

The political consequences of these infructuous policies is now clear.  The domestic corporates are almost all waiting for the end of UPA II and the emergence of the BJP under Modi, a man who assiduously cultivated corporate contacts while the UPA government was clobbering them. Young workers, confronted by a tighter job environment provided the support for the burgeoning anticorruption movement.  As for the impact of the rural largesse, the UPA misread the changing rural mind set which is looking not for doles but for opportunities. Look at the result in Rajasthan where besides the Central schemes, the State implemented additional welfare schemes and yet with a disastrously poor electoral outcome for the ruling party.

Today India’s growth potential is constrained by its politics. The fault does not lie only with the Congress.  There is a deeper structural problem in that political expression of interests and sentiments through the party system is getting fragmented. In 2009 370 parties contested the elections and 39 parties are represented in the present Lok Sabha. Two national parties, the BJP and the Congress get barely 50% of the vote between them. The explosion in number of parties reflects failure of two national parties, Congress and BJP, to accommodate regional/caste/religious identity assertion. The Congress is incapable of tolerating strong regional leaders because of their perceived threat to the hegemony of the apex power structure in the party.  The BJP more able to accommodate strong local leaders but is centralised because of ideological controls of the RSS.

Coalition governance at the centre is now inevitable. But we have yet to learn the coalition dharma that goes beyond turning a blind eye to the shenanigans of regional partners and builds on the need for a measure of ideological compatibility and an agreement on a common programme as a basis for forming coalition governments. 

A massive swing to the BJP could bring in a more decisive government under Modi.  But it may not last long as Modi’s authoritarian style will not work at the Central level where the government has to work through the State governments who have effective implementation authority over development (energy, roads, irrigation, education, health, etc.). He cannot treat Jayalalita, Mamta Bannerjee, Nitish Kumar and Naveen Patnaik the way he handles his ministers and their departments in Gujarat. Every other alternative promises a weak coalition at the Centre.

But all is not lost.  The political system is effectively bipolar at the State level and the growing weight of performance in voter evaluations is reducing the importance of caste based vote banks. At the present stage of our political evolution the cause of growth and development would be best served by a lightening of the visible hand of policy control at the Centre leaving more room for the States to innovate and compete for investment and job growth. At the same time measures like the GST can prevent such competition from becoming dysfunctional and tight fiscal discipline may help to avoid the dangers of competitive populism

In the longer run the young voters of India may move away from identity politics to a party structure crystallised around a right of centre party like the BJP and a left of centre party that could be a democratised Congress.