The outcome of India’s 2019 elections could define its economic and social development path for the next decade. The world’s fastest growing large economy (and largest democracy) sits at the cusp of a potential demographic dividend, with two thirds of its population under the age of 35. But to realize this dividend, it needs to have the right policies in place and implement them effectively.
The structural reforms implemented by the Bharatiya Janata Party (BJP) and its ally (National Democratic Alliance, NDA) since their 2014 landslide electoral victory have greatly improved India’s international ranking in the World Bank’s Ease of Doing Business index (up by 65 places in 2019 to 77). However, there is still much to change before India can realize its full economic potential, and the pace of progress rests on whether the NDA or the opposition Indian Congress and its allies (United Progressive Alliance, UPA) wins the election and the nature of their economic policy and structural/social reforms.
Voter Concerns and Reform Progress
The NDA is generally expected to win but with a reduced majority. However, electoral forecasts currently range between 200 and 250 seats (272 are needed for a majority) so victory is not assured. Given the possible outcomes, it is important to understand the issues the country faces (Figure 1), the proposed solutions by both sides and their market implications.
As Figure 1 shows, job opportunities, corruption and inflation play a major role in voter concerns. While the NDA has implemented several reforms since 2014, some of these have been controversial, including the demonetization of 86% of the currency in November 2016. The stated object of the exercise was to tackle corruption in the informal economy, but the National Bureau of Economic Research1 estimates that the policy reduced national activity by two percentage points in Q4 2016. Similarly, the Goods and Services Tax (GST) system, finally introduced in 2017 after long delays, has been criticized for being too complex. Despite these issues, India’s GDP growth is expected to grow 7.3% in FY 2018-19 (April to March) and 7.5% over the next two years2. In addition living standards (GDP per capita) have increased (Figure 2).
The fiscal deficit, meanwhile, has been kept in check thanks to declining oil prices and higher revenues from direct taxation and disinvestment receipts (Figure 3). The Direct Benefit Transfer of subsidies to people below the poverty line through their bank accounts has also reduced leakages and delays. Petrol and diesel prices have been deregulated, but subsidies on fertilizers, electricity, MNREGA (Mahatma Gandhi National Rural Employment Guarantee Act 2005) and food still form a large share of government expenditure.
The implementation of the Insolvency and Bankruptcy Code (2016) has been instrumental in identifying delinquent assets and the Non-Performing Asset (NPA) growth rate has slowed impressively since then. Foreign Direct Investor (FDI) regulations in several key sectors including civil aviation, defense, food and single brand retail, pharmaceutical and airports have been relaxed to encourage investments under the ‘Make in India’ campaign.Despite these measures and considerable investments in infrastructure such as electrification, rural highways and housing, there remains a lot of capacity in the economy that is not part of the top-line GDP growth story. To close this gap and to capitalize on the demographic dividend, the next government will need to focus on improving the ‘employability’ of young people through education and training and on including more women in the workforce.3
Policy Implications of Different Electoral Outcomes
Overall, we expect the broad thrust of modernization and development to continue irrespective of who wins. Both coalitions are fragile, though arguably the UPA is more susceptible to fracture, but key ideological differences4 persist between the two groups.
For example, while the NDA tries to tackle agrarian distress by expanding direct benefit transfers and making short-term new agriculture loans to marginal farmers, the UPA promises further loan waivers and a separate Kisan (Farmers’) Budget. While both measures create some fiscal strains, loan waivers have tended to induce fiscal and credit indiscipline and their effectiveness is questionable5. Overall, the NDA’s manifesto seems to be slightly better balanced in terms of growth and fiscal prudence. With regard to job creation, the NDA’s manifesto is focused on increasing manufacturing and self-employment, while the UPA promises to create 10 million low-skilled public sector jobs. The NDA also aims to engage young people by encouraging sports given the accompanying health benefits and the potential to acquire life-long skills.
How Will Markets React?
While election outcomes tend to have limited impact on financial markets over the medium to long term relative to fundamentals, there may be a knee-jerk reaction in equity markets post the results. Figure 4 shows Foreign Institutional Investor (FII) flows around major elections in India, which typically influence equities. Given strong flows around the last election cycle, FIIs may well become net sellers on the back of either a big loss for the NDA or a muddled coalition. The strong performance of MSCI India relative to MSCI EM (~4.2% better annualized returns) in 2014 came with expectations of a stable five-year government and structural reform. Additionally, the current buoyancy in equity markets has coincided with the better performance of the NDA at the polls, which suggests markets will be more sanguine about a continuation of the current policy environment.
The post-election performance of equities has typically been flat or positive (Figure 5). Moreover, at this juncture, certain trends indicate a possible improvement in the earnings cycle: (1) the NPA cycle is nearing its end and (2) there is potential for a pickup in industrial earnings as private capex starts recovering after a period of consolidation of excess capacity and corporate deleveraging. Whoever wins, we expect the Reserve Bank of India to maintain its dovish-neutral stance, given inflation remains relatively benign. This could change if oil prices rise sharply from here and result in some correction in the value of the rupee.
It is therefore critical that the next government maintains fiscal discipline, while making further capital market reforms to attract overseas investment and support the domestic currency. Capital account convertibility and better overall governance standards are crucial in this regard. PM Modi’s incumbent government has introduced several reforms (some more successful than others) designed to aid India’s development and the likelihood is, that if he is re-elected even with a smaller majority, we could see more of the same. But future reforms6 will need to be introduced quickly and span many more areas such as infrastructure, manufacturing and primary education, if India is to alleviate “supply side” constraints on growth and job creation and continue to make headway. Labor reforms to increase female and youth labor force participation will also be crucial.
1 Source: https://www.nber.org/papers/w25370.pdf
2 Global Economic Prospects, South Asia, World Bank
3 Gender Equality Better for Growth, Debt, Income equality & Sustainability (SSGA Research, March 2019)
The views expressed in this material are the views of Kaushik Baidya, Gaurav Mallik, Simona Mocuta and Amlan Roy through the period ended 05/14/2019 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
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