Capital Ideas^TM

India’s incumbent Prime Minister Narendra Modi and his Bharatiya Janata Party (BJP) have secured a third term, with the BJP-led alliance clinching a narrow win in the country’s closely watched national election. However, the race was tighter than expected, creating some uncertainty about the direction of the country over the next five years. India’s equity market fell sharply on the news.

In the six-week election that began in April, the BJP won 240 seats in the country’s 543-member parliament, falling short of market expectations of 300 or more and the 272 seats needed to get a simple majority. The result was also less than the 282 seats the BJP secured in 2014’s election and 303 in 2019. The outcome means India will once again see a coalition government after 10 years.

This is a big disappointment for the BJP, which went into this election expecting to easily best its 2019 result. The Party waged its election campaign in the name of Modi, and clearly at the margin, that brand has diminished. 

Here are a few ramifications I see as we await the formation of the new coalition government, selections to key cabinet posts and July’s national budget.

A coalition government could slow decision making. Modi has never led a coalition government, and he will have to change his style of running the government significantly.

The election results will likely impede his ability to appoint technocratic ministers. The profile of the new cabinet, as well as those key ministry posts non-BJP party members demand or receive, will give us a better sense of how the new government will function. I would stress that a coalition government does not necessarily mean a doomsday scenario. It was India’s modus operandi from 1989 until 2014, when Modi was first elected as prime minister. Under various coalition governments, both the economy, reform agendas and markets have done reasonably well.

In the new parliament, the BJP will probably find it difficult to push through unpopular but necessary policy and reform measures. The privatisation of banks could be one early casualty. Hopes of progress in land and agriculture will likely be ratcheted back as well. It would be easier to push reforms and decisions that do not require a change in legislation, as the opposition will have a significant voice in parliament. There will be more checks and balances in the functioning of the government and its various institutions.

Policy implications: It is likely we could see looser fiscal policies, which rubs against the grain of BJP’s core ideology. Distress in India’s rural areas and joblessness were dominant themes in the opposition’s narrative. Further financial support to rural India and poor households would strain the government’s investment budget and/or increase the country’s fiscal deficit. Private sector investment decisions may be pushed back as well. While I expect that most of the focus of the previous government will continue, the delays in reform and policy measures could hinder expansion of the manufacturing sector. The new government will have to think more urgently about employment and job creation. In his first speech after the election results, Prime Minister Modi reiterated that the new government would continue the policies of his outgoing regime.

Will Modi be replaced as Prime Minister? It is possible but seems unlikely. There are two scenarios under which there can be a new prime minister. First, BJP alliance partners demand a change and want someone who is more flexible. Second, BJP alliance partners walk out of the coalition to support a coalition led by the Indian National Congress Party. Both seem highly unlikely as of now. Moreover, Modi still remains India’s most popular politician and continues to have very high approval ratings overall. After 10 years in power, the BJP is the single largest party in parliament, and its share of seats is more than the number held by the opposition alliance led by the Congress Party.

What were other surprises in this election? The biggest surprise in this election was from Uttar Pradesh, a northern state that holds 80 seats in parliament. I had expected that the BJP will hold its ground and most likely increase its seat share. However, BJP won only 33 seats versus 62 in 2019 and 71 in 2014.

Equity markets are likely to be volatile after a strong run. Markets will likely be volatile until there is more clarity on the formation of the cabinet, the key ministers and the policy direction of the new government. The biggest risk to the incumbents is if the Congress Party can successfully woo BJP allies. If successful, this may muddy the economic agenda.

While the cabinet formation should be known in a couple of weeks, the budget in July would be one of the first statements on the direction of economic policy. Until then, small- and mid-cap stocks could continue to face selling pressure, particularly in sectors dependent on continued government policy momentum. If the past is any indicator, then the market’s immediate reaction usually reverses once a new government is formed, and the trajectory of growth and reform become clearer. I expect that the general trend of an upwardly mobile market will continue.