An Indian factory worker using a textile fabricating machine at a production unit in the south Indian city of Tiruppur. Arun Sankar | AFP | Getty Images

Prime Minister Narendra Modi won a strong mandate at the recent Indian parliamentary elections, but his government has its work cut out for the second term: India's economic growth has notably slowed down — falling behind its rival China, and its unemployment rate is at a 45-year high, according to recent data. Lackluster job creation in South Asia's largest economy was one of the pressing issues during Modi's first five-year tenure — a fact that was repeatedly criticized by the opposition during the election campaign. Economists told CNBC that India needs to do more to create new jobs, which can happen only with better policy-making both by the central government, led by Modi's government, and at the state level.

Rising unemployment

India's National Statistical Office recently released the periodic labor force survey for the period from July 2017 to June 2018. It showed that the unemployment rate was at 6.1% — significantly higher than the 2.7% registered in the last survey period between July 2011 to June 2012. Meanwhile, the labor force participation rate came in at 36.9%, with a disproportionately lower percentage of women looking for work during the survey period. That number was comparatively lower than many other OECD countries. The government argued that the numbers should be seen in isolation as they were derived using a new methodology. But at least one economist expressed concern. "It is a very worrying trend," Sanjay Mathur, chief economist for Southeast Asia and India at ANZ bank, told CNBC. He explained that there were several long-term trends that contributed to the relatively high unemployment figure.

State-level policies have huge implications for local conditions. Shamika Ravi director of research at Brookings India

First, growth in the business process outsourcing industry — a key source of employment in India — has slowed over the years as more companies shift to cheaper places like the Philippines. Business process outsourcing refers to instances where a company outsources non-essential operations to a third party. The construction sector, another source of jobs, also weakened in recent years. Finally, Mathur said, India's poor infrastructure set-up means the country cannot tap into opportunities that opened up when China exited a number of labor-intensive activities to modernize its economy. In the short-term, the implementation of the Goods and Services Tax in 2017, and the unexpected currency reform a year earlier, also hurt many small- and medium-sized firms — and some had to shut down or retrench part of their workforce. That, Mathur said, also contributed to the unemployment figure but the situation is expected to be rectified in the coming years.

Variation among states

The latest employment data showed some Indian states fared better than others. In states like West Bengal, unemployment was 4.6% — below the national average. But other states like Kerala, Delhi, and Tamil Nadu had relatively higher figures of 11.4%, 9.7%, and 7.6%, respectively. The varying levels of unemployment in different states were a concern for some economists even before the latest jobs data were released. "There are very serious variations when you go from one state to the other," Shamika Ravi, director of research at Brookings India, told CNBC in New Delhi in April. Ravi explained that it is the business climate in individual states that drive job creation, more so than policies implemented by the central government in New Delhi. "State-level policies have huge implications for local conditions," she added.

For Sankalan Dutta, a telecommunications engineer working for Vodafone in Pune, those local conditions pushed him to seek employment opportunities away from Kolkata, the capital city in West Bengal, where he was working for about six months at the start of his career. He told CNBC he started looking for better opportunities as the first job he had was not something he wanted to do. When one became available in Delhi, he moved. "Today, the (job) I'm working on is not available in Kolkata," he said. "Even if it is available, it is very low in number. It's very difficult for me to find a job in Kolkata that fits my profile." Overall, he said, it's become harder to find the right kind of jobs in India's IT industry. "It's not like I'm at the same skill level. I'm continuously upgrading my skills. Still, it is getting difficult," Dutta said. Anurag Sarkar, an assistant professor at the Future Institute of Technology in Kolkata, echoed those sentiments. About 30% to 40% of the graduates from his civil engineering department get recruited right after graduation, he said. But many of them end up working in areas like sales and business processing, or at call centers, even though they are trained as engineers. "Their motivation drops," Sarkar told CNBC in Bengali. He explained that those jobs get them so-called "easy money" where they're able to earn a salary with little effort. It is detrimental to their long-term prospects, said Sarkar, adding that West Bengal needed more large-scale industries — such as manufacturing and steel — to drive private-sector job creation. Many people who are unable to find jobs also end up starting small businesses.

What can be done

Economists agree that better policy decisions are required — both at the central and state levels — to improve the conditions needed for job creation in India. In many instances, state governments can follow a different agenda than New Delhi, even if members of the same party are in charge. Modi's second term as prime minister looks set to be defined by his ability to pass tough, controversial reforms on the country's labor and land laws. The expectation is that if those changes come through, it would potentially improve India's global competitiveness, growth and create more jobs.

India is a services-driven economy but the country has a large pool of low-skilled workers who are better suited to do low-end manufacturing jobs, according to Priyanka Kishore, head of India and Southeast Asia at Oxford Economics. But those labor-intensive sectors are not growing and current laws work against the so-called economies of scale, she said. "It is in the benefit of an industrialist to actually have a smaller set-up than run a large factory," Kishore told CNBC. She explained that if existing laws can be changed to encourage labor-intensive industries to scale up, it would generate more employment. That said, Kishore felt it's likely that the Modi government would initially focus on fixing the more pressing problems, including rural distress, before working to pass tough reforms to generate long-term employment.