India’s state sector is thriving under Modi. That’s a problem

By Mihir Sharma

Ten years ago, when Narendra Modi — then chief minister of business-friendly Gujarat state — rode an electoral wave to the prime ministership in New Delhi, many expected that he would be far more supportive of the private sector than previous Indian leaders. As a candidate, Modi was quoted as saying: “I believe government has no business to do business,” and one of the many slogans of that 2014 campaign was “minimum government, maximum governance.” That seemed as close to laissez-faire Thatcherism as one could reasonably expect in India.

Nobody who looked closely at Modi’s tenure in Gujarat, however, believed this easy narrative. His proudest achievement there was turning around the state government’s own public-sector companies, particularly in the energy sector. And that’s been his focus in national office as well. In one recent interview, when asked to cite an example of how the markets should react to his expected re-election, he pointed specifically and solely to how he had revived the stock prices of public-sector companies.

Modi wasn’t wrong. State firms have done better than India’s benchmark Sensex index for three years straight, and look likely to do so again this year. They have regularly traded at a premium to their private peers.

Government officials attribute this success to administrative shifts within these creaking old behemoths. The minister in charge of India’s state petroleum companies, for example, says that the Modi administration has introduced a “new era of governance characterized by professionalism, strategic foresight, and unwavering commitment to national interests.” Most analysts are similarly optimistic, if less effusive.

But what does this public-sector outperformance say about India’s real economy? Is such vibrancy really worth bragging about?

Two bits of context are worth noting. First, most of India’s state-owned enterprises are in legacy sectors — fossil fuels, old-style transport, 20th-century capital goods. And second, private-sector investment in India remains anemic.

Consider these three points together, and the macro picture begins to look a little worrying. If what are known in India as “public-sector undertakings” are doing well, is that because the private sector is under-performing on growth and investment? And is it good news if the best-performing companies in an economy are those that hold near-monopolies in sunset industries?

Analysts at Kotak Institutional Equities have argued the latter is a real problem. “Continued large reinvestment of cash flows by PSUs into their extant businesses (mostly sunset industries) may constrain their ability to invest in more future-proof businesses — key to their longer-term viability.”

A cycle — whether virtuous or vicious — is at work here. State-owned companies dominate certain older sectors. They see decent cash surpluses. But, being government-controlled, they can’t channel their profits into the broader financial system to find the most effective new projects. Instead, they must follow directions from New Delhi to re-invest in their own industries.

Meanwhile, private firms in India are struggling. New investment plans from the private sector shrunk by over 15 per cent in 2023-24. Manufacturing suffered the biggest hit, as fresh proposals fell by 40 per cent in value terms, from Rs 20 lakh crore in 2022-23 to Rs 12 lakh crore in 2023-24.

Economists have come up with various explanations for the declines. Some argue that domestic demand is still not robust enough for the private sector to make a business case for new investment. Others point out that productivity in manufacturing has barely increased, so fresh capital has not been drawn into the sector. And pretty much everyone agrees that business-friendly reforms have not gone far enough.

A more fundamental problem is that Modi has developed a battle-plan for economic growth over his past two terms — and the private sector isn’t meant to lead the charge. The government actively mops up household financial savings and routes all investment through the state sector. As a share of GDP, government expenditure has increased sharply, as has India’s debt. The finance ministry’s think tank estimates growth in the coming year will be an optimistic 7.1 per cent-7.4 per cent, essentially thanks to public-sector capital expenditure.

This strategy is, to put it mildly, not Thatcherite. It certainly won’t modernize India’s economy away from sunset industries. Nor will it increase productivity — that’s asking too much of the public sector.

Above all, it is fiscally unsustainable. Government investment has risen in every federal budget; how long can India keep that up? If Modi returns to power, his administration must adopt a different strategy. State-owned companies can’t be the basis of a modern, productive economy.