Saffron, the official color of the Bharatiya Janata Party (BJP), prevails in the provisional election results that were announced today. In a marathon election that lasted six weeks and saw 600 million Indians cast their vote, Modi managed to obtain a landslide victory that surpasses his previous win in 2014 in terms of seats. Modi is returning to power with one of the strongest mandates in the lower house since 1984. BJP crossed the required halfway mark themselves, and with allies obtained nearly two-thirds of the seats. Attempts by the opposition parties to unite in key states to defeat BJP have clearly failed, with some parties even being decimated.
We believe this victory is very positive for the BJP and will bring stability and policy predictability. Modi’s popularity previously took a hit when he implemented some unpopular reforms, such as the Goods & Services Tax and demonetization. While the benefits of these will materialize in the longer term, they caused a short-term blip in economic growth. Nevertheless, the election results indicate that at grassroots level, many still believe Modi is the right man to drive prosperity going forward.
From an economic perspective, Modi’s task won’t be easy. The Indian economy has moderated from a growth perspective, consumer demand has weakened, and exports have declined. Room for fiscal stimulus is limited as the government aims to pursue its ambitious path towards fiscal consolidation. However, there are other means by which they can provide stimulus. Further subsidy rationalization, for example, may increase cash transfers to poor people. From a monetary perspective, lower inflationary pressures will keep interest rates low. Current weakness in consumer demand can be partly attributed to tighter liquidity conditions since late last year, following a credit default in the non-banking finance segment. A more accommodative monetary stance from the Reserve Bank of India can be expected as real rates remain in positive territory and will hopefully normalize liquidity conditions.
Other areas the government might focus on include simplifying rules for the small and medium-sized companies (labor law simplification), boosting financial sector reforms and creating manufacturing jobs. One of Modi’s main objectives in the past five years has been to kickstart the ‘Make in India’ campaign and attract foreign direct investment. As a result of the global trade issues between the US and China, companies are moving their capacities out of mainland China towards South-East Asia. A stable government means that India can now also become a manufacturing destination. Improvements in the country’s ‘ease of doing business’ ranking over the past few years should help as well. This also means that the government will continue to focus on investing in infrastructure, which has been the country’s Achilles heel in terms of attracting foreign direct investment into India.
After the terrorist attack in Pulwama on 14 February this year, Modi’s call for unity and military retaliation against terrorist camps in Pakistan boosted his popularity. National security became an important topic on the election agenda and the Indian equity market started pricing in a higher probability of a ‘saffron wave’ (BJP victory).
Now that the elections are over, investor focus will return to macroeconomic fundamentals and the extent to which the government can drive a recovery. Like the price of saffron spice, buying into the Modi’s ‘saffron wave’ is not cheap. Corporate earnings, which are neither surprising nor disappointing for the previous quarter, have to accelerate to justify current valuations. Although the Indian market is trading at elevated levels, we are still able to find some pockets of value in certain sectors, such as banks.
India still faces external risks as well. In addition to factors such as global sentiment, India remains vulnerable to oil shocks. For every USD 10/bbl increase, India’s GDP is impacted by roughly 0.3% as it imports more than 80% of its oil needs. A higher oil price means higher input prices for companies, and thus lower earnings. Shortly after Modi came into power for the first time in 2014, he received a huge ‘oil dividend’. Oil price corrected sharply from mid-2014 onwards, giving Modi a helping hand. It is difficult to predict where the helping hand will come from this time around. Lower interest rates are supportive for valuation levels and low exposure to the global economic slowdown makes India a defensive destination for emerging market investors. But perhaps the biggest helping hand will come in 2020, when BJP and its allies are expected to secure a majority in the upper house. This would enable them push through important and long-overdue legislative changes.