Short Insight: India – World’s largest elections bring Modi 2.0

by: Arjen van Dijkhuizen

  • PM Modi secures second term with an even stronger mandate
  • Financial markets react positively, as Modi 2.0 bodes well for reforms
  • Economic growth slowed, but some pick-up expected after elections
  • Some room for further rate cut(s), but RBI might be cautious in June
190522-Short-Insight-India.pdf (361 KB)

1. PM Modi secures second term with an even stronger mandate

Over the past six weeks, the world’s largest elections (around 900 mln eligible voters) have been held in India. Central question was whether the centre-right coalition (National Democratic Alliance, NDA) led by PM Modi’s hindu-nationalist Bharatiya Janata Party (BJP) would be able to stay in power and keep its parliamentary majority. The ruling coalition had lost some of its popularity since Modi’s impressive victory in 2014, partly due to problems in the agricultural sector and high job losses at SMEs. However, with votes still being counted, preliminary results suggest Modi will gain a second term as Prime Minister with an even stronger mandate. According to these interim results, the BJP itself is set to gain an absolute majority of around 300 seats in the 543-member Lok Sabha (the BJP currently hold 269 seats and the whole NDA 341). That would mean that the election results are even better for Modi than recent opinion polls had suggested. It seems that Modi and his government coalition have profited from the flaring-up of tensions with arch enemy Pakistan over the past few months. Presumably, the electorate has approved Modi’s firm reaction to the terrorist attacks in Kashmir in February 2019 by a Pakistan-based militant group.

2. Financial markets positive, as Modi 2.0 bodes well for reforms

Based on the results known so far the election outcome is favourable for India, at least from an economic policy point of view. After having struck by policy paralysis for many years, Modi’s strong mandate gained in 2014 opened the doors for structural reforms, which are highly needed given India’s challenges in its physical and institutional infrastructure. Modi started with low hanging fruit such as improving the business climate. Still, he also succeeded in pushing through some more controversial reforms, such as a new bankruptcy code, a country-broad tax for goods and services and a large currency clean-up. These moves were visible in improving rankings on Doing Business and Global Competitiveness. In the run-up to the 2019 elections, the government shifted to a more populist agenda (such as improving welfare programmes). Still, in our view, Modi 2.0 has the potential to deepen reforms further, which would contribute to India being able to reap its growth potential and to remain the fastest growing emerging giant. The elections (and exit polls) have been positive for India’s stock and bond markets so far.

3. GDP growth slowed, but some pick-up expected after elections

After having picked up to around 8% yoy in the first half of 2018, real GDP growth slowed to 7.0% in Q3-18 and 6.6% in Q4-2018, the lowest pace in five quarters. The slowdown at the end of 2018 was mainly driven by weaker government and private consumption. The latest high frequency indicators do not bode well too. After surging end 2018/early 2019, the manufacturing PMI has fallen by 2.5 points in the past two months, to an 8-month low of 51.8 in April. The Services PMI has also come down and the Composite PMI fell to a 7-month low of 51.7 in April. Industrial production growth has also fallen back, being stagnant in annual terms in February and March. This weakening picture partly relates to pre-election uncertainty, but a challenging external outlook and a softening of credit growth (partly reflecting a couple of bank sector problems) also play a role. With election uncertainty out of the way now, we expect some improvement in momentum. We have kept our growth forecasts for the coming fiscal years unchanged at 7.5% so far.


4. Some room for further rate cut(s); RBI might be cautious in June

Headline inflation has fallen sharply since mid 2018 (driven down by falling food prices which account for around 40% of India’s CPI index), from almost 5% yoy in May/June 2018 to a 19-month low of 2.0% yoy in January 2019. Over the past few months, inflation has picked up somewhat again, but remains clearly below the RBI’s medium-term target of 4% +/- 2%. On the monetary policy front, our expectation of a more dovish approach under governor Das has materialized. In the first two rate setting meetings chaired by him (in February and April), the RBI cut the repo rate twice by 25 bp (to 6.0%). All in all, the ‘real policy rate’ (nominal policy rate minus current inflation) has come down somewhat in recent months, but is still at relatively high levels (almost 3.5% in April). Hence, we see room for one or more rate cuts, also reflecting the more dovish stance of the Fed (we expect the Fed to stay on hold in 2019-20). That said, the RBI might prove to be cautious in its early June meeting. While the rupee has held up relatively well recently (partly related to the election process), EM currencies in general have felt the impact from the rise in risk sentiment on the back of the re-escalation of the US-China conflict.