What’s In Store For Indian Markets And The Economy After Elections?

As national elections kicked off on Friday, two questions emerged uppermost on investors’ minds: What if Prime Minister Narendra Modi has to lead a coalition government where his Bharatiya Janata Party (BJP) does not have a Parliamentary majority on its own? And, what would his third term entail in terms of policies if Modi comes closer to his target of 370 seats for the BJP and gets past 400 with allies?

Societe Generale’s research arm Bernstein, which analysed the risk of election surprises in an India strategy report released last Friday, said the optimistic scenario (400+ for BJP and allies) has now become the base case. Despite opinion polls providing even more optimism, Bernstein caught on to something political scientists have been vexing over for weeks — with the BJP-led National Democratic Alliance (NDA) having scored 353 seats in 2019, where will the additional 50 seats come from? Will the South, except Karnataka, largely a holdout for the BJP so far, deliver this time? 

The opinion poll consensus is that it is unlikely. But then, voter behaviour is unpredictable. The Congress won three-fourths of the seats in Kerala in the elections held after the Emergency in 1977, for instance. But the state went in the opposite direction when the rest of the country voted for the Congress in 2004, delivering it just five seats out of 20. So the possibility is real even if the probability is low. 

Stability And Growth

Despite multiple elections, India has had leadership stability and policy continuity for 26 years. It has had only three prime ministers since 1998. Despite two of them heading coalition governments, long-term economic growth has remained stable. Its GDP has risen 10 times; from over $400 billion in 1998 to close to $4 trillion now. 

All three leaders found economic highs as well as hit troughs. While the Atal Bihari Vajpayee government (1998-2004) kicked off a growth revival after the dotcom bust, it was limited to industry and failed to reach the grassroots. The Manmohan Singh era saw one of the best periods of growth and investment but was also plagued by what is now known as policy paralysis towards the fag end. The Narendra Modi regime has delivered on several reforms and put in place transformative physical and digital public infrastructure but has also overseen democratic backsliding. It has been described as “one of the worst autocratizers”, according to the ‘Democracy Report 2024’ released by the Gothenburg-based V-Dem Institute, which tracks democratic freedoms. 

Global headwinds buffeted each of these leaders’ terms. Vajpayee’s term was hit by US sanctions, while Singh was in the middle of his tenure when the Global Financial Crisis erupted. Modi had to deal with the worst pandemic the world has seen in over a century. Investors will perhaps ignore internal politics. As one analyst told The Core, “electoral autocracy is a part of life.” But the same cannot be said about economic conditions.

Wait For The Trilemma

So what would post-election India be up against? Equities are expected to correct when the election results are announced. If the BJP does not perform as per expectations, the slump could be sharp and deep. The Nifty has gained 26.74% in the past one year. Some investors will exit, but it will also present fence-sitters turned off by high valuations with a buying opportunity. About $20 billion inflows are expected in June into bonds because of India’s inclusion in the JP Morgan Bond Index. Dollar inflows combined with a commodity upcycle could fuel inflation and make it difficult for the Reserve Bank of India to lower interest rates, presenting a difficult situation for the government when it presents its budget for the rest of FY25.

The rupee slid to a record low of 83.57 against the dollar on Friday. There may be worse in store as commodity prices harden. 

The Russian oil bonanza is nearing its end. The discounts have shrunk 77% from their peak last year, eating into the refining margins of oil companies. With West Asia on the boil, oil prices will continue to swing, keeping India’s current account off kilter. US sanctions on Russian-origin aluminium, copper and nickel are pushing up their prices. Copper, extensively used in electric vehicles, is nearing $10,000 per tonne. India’s copper imports were up 30% in 2023. It will impact EV and electronic goods manufacturing in India. Aluminium prices will impact multiple sectors, including auto and construction. 

Meanwhile, US rate cut hopes are now receding as the economy continues to be strong and inflation remains outside the Federal Reserve’s comfort zone. It is possible that the Fed may not cut rates at all this year. High interest rates have kept the dollar buoyant and it will stay up as bearish currency traders are reversing their bets. An adverse commodity cycle coupled with a strong dollar is a double whammy for India. It can only mitigate it by taking advantage of the weaker rupee to export more. That requires raising capacity utilisation and investing in additional capacity, something the government has been trying to stimulate for the past nearly two years. That’s where the current interest rate regime comes into play. 

The RBI is not yet confident that inflation, especially in food prices, has been tamed enough and hence, has not cut rates. RBI Monetary Policy Committee member JR Varma believes that the current rate — repo rate of 6.5% — is excessively high. Varma cautioned the rate-setting panel when it met on April 3-5 that “high interest rates entail a growth sacrifice”, recently released minutes show. 

Varma also told Moneycontrol in an interview that revival of private sector capex was in jeopardy because of high interest rates. That perhaps will be the new government’s foremost task: boosting private capital expenditure.