Indian elections: does Modi matter?

“Politics is the art of the possible, the attainable – the art of the next best.” Otto von Bismarck.

General elections are underway in India, beginning today and concluding on 19 May. All being well we should have the results on 23 May, when we find out whether the incumbent Bharatiya Janata Party (BJP) will remain in power under the current prime minister Narendra Modi, or if the Indian National Congress (INC) under Rahul Gandhi will return to power. We could even end in a third party coalition scenario, with the two main parties consigned to supporting roles at best.

Whatever the outcome, we think it is best not to overegg the likely impact on India's economy, which in our view faces only incremental change under any victor.

Taking the electoral temperature

Eyes will increasingly be on opinion polls as the elections loom, particularly because in recent months it had looked as though the BJP's coalition, the National Democratic Alliance (NDA) were under threat. Local elections toward the end of 2018 reinforced this perception, with the BJP losing ground to the INC.

However, as this narrative was gaining hold it was interrupted by chance; on 14 February a Pakistan based militant group killed 40 Indian police in a suicide car bombing. Tensions escalated rapidly and culminated in the capture and subsequent return of an Indian Air Force pilot following a dogfight over the skies of Pakistan.

Prime Minister Modi received a strong boost to his personal ratings from his handling of the incident which appears to have translated to gains for his party as well. The BJP, as a Hindu nationalist party, is also the natural political beneficiary of inflamed tensions with a Muslim neighbour.

It looks likely then that the BJP will return to power, though probably with a reduced majority. What does this mean for India?

Measuring Modi

Assessing the prospects of another five years under Modi and the BJP might be easier if we look at their record to date. We would argue that in 2014, when Modi was elected, much of the euphoria centred on the belief that he would revive the Indian economy and boost investment with business friendly reforms. Against these criteria, there have been some successes, but the “Modimania” of 2014 was ultimately not justified.

Chart 1: The scorecard is mixed for the first term

Source: Thomson Datastream, Schroders Economics Group. 20 March 2019.

Looking at the main macroeconomic headlines (chart 1), things do seem to have been better under Modi. Income growth, as measured by gross domestic product (GDP) per capita, has been consistently strong compared to a volatile track record previously, and inflation looks low by historical standards. However, the five-year average GDP growth rate is no higher than was achieved under the previous government (5.94% in 2018 against 5.98% in 2013).

The reduction in the volatility of economic activity is definitely a plus, but it is hard to point to Modi as a catalyst for economic resurgence. Meanwhile, inflation, as measured by the consumer price index, has undoubtedly improved but arguably this was down more to the central bank under Raghuram Rajan (who began his tenure before Modi's election, in 2013) than to Modi's government. Finally, investment as a share of GDP is actually lower under Modi than his predecessors.

The performance of Indian equities gives a similarly mixed picture (chart 2). After a year of solid outperformance versus the rest of emerging markets (EM), Indian equities have moved broadly in line with the rest of the EM universe. Excitement over the prospect of a Modi led government was ultimately not borne out by reality.

Chart 2: From mania to meh-nia in Indian equities

Source: Thomson Datastream, Schroders Economics Group. 23 March 2019.

This is not to suggest that Modi has not had any policy successes; the passage of the Goods and Services Tax is arguably the highlight, but measures on bankruptcy resolution and a number of smaller reforms have also been positive for the economy. A reduction in subsidies, the continued roll out of the biometric ID scheme, and improvements in general governance should all be tallied in Modi's favour as well.

Against this, we should offset the big policy mistake of demonetisation, and the failure to pass land and labour reform. Demonetisation saw the surprise withdrawal of 86% of the currency in circulation in an effort to reduce corruption and tax evasion. However, the process caused disruption to the economy and was deemed a failure as the central bank estimated 99% of the notes were exchanged for new currency. While this was an unforced error, it seems likely that any government would struggle to pass the banner reforms of India's land and labour markets. These two are arguably the key to driving Indian industrialisation.

The art of the possible

Ultimately we think Modi's record reflects more on India than on the man himself. A huge democracy with strong regional parties and only rare outright majorities, India's system does not lend itself to quick reform and dramatic change. As an example, the Goods and Services Tax (GST) was first proposed in 1999 and pursued by both NDA and United Progressive Alliance governments until Modi's government, which enjoyed a majority in the lower house but not the upper, finally succeeded in 2017.

This has certain implications for the outcome of this election. Whoever wins, we should not expect any sweeping policy changes, in either direction. Modi will presumably continue to follow a broadly pro-business agenda, but with a reduced majority will find it even more difficult to push through contentious reforms. A victory for the Congress party, or a third party coalition, might initially worry markets. However, as illustrated by the attempts of both Congress and BJP governments to enact the GST we think that there is less space between the policy stances of the main parties than is commonly imagined. In addition, once in government, practical realities reduce the differences further.

From a market perspective, this would leave us inclined to fade any strong reaction to the election outcome. Absent a single party winning an overall majority in both the lower and upper houses, aggressive reforms seem to be off the agenda. Land and labour reform have been delegated to the state level (with some promising results) and are off the national agenda for now.

Consequently, the path India follows for the next five years looks set to be similar given the range of plausible outcomes. This does not mean, of course, that a Modi victory would not prompt a rally, nor that a Congress victory or even hung parliament would not see a sell off. But ultimately we would see either move as a sentiment led response. India is set for gradual, incremental improvement, and expectations should be accordingly calibrated to cautious optimism.