Making Sense of India’s Election Shock

What happened?

India’s election results have taken everybody by surprise. They were certainly not in line with expectations for political continuity. In 2019, Narendra Modi’s Bharatiya Janata Party (BJP) was re-elected with an overall majority in parliament of 303 seats and a decisive mandate. In 2024, India’s general election results suggest that the BJP will win around 240 seats*, well short of the 272 needed for an outright majority.  

Given that the National Democratic Alliance, which includes the BJP and its two main allies, is still the biggest elected group, we expect that the BJP, being the largest party in the group, will form the next government. Modi has secured the backing of BJP’s two key partners, the Telugu Desam Party and the Janata Dal (United) party but it is potentially a fluid situation. The BJP has the ability to offer far more money, stability, and also power sharing to its coalition partners than the opposition. However, what will ensue is likely to be some significant political jockeying between elected parliamentary members.

What does it mean for economic policy?

Over his decade in power, Prime Minister Modi’s focus was on infrastructure development in India. Economic growth was led by gross fixed capital formation while consumption growth came down dramatically. For fiscal year 2024, for example, consumption growth was only 3% to 4%. In simple terms, post-COVID, the economic recovery in India has been K-shaped, with some sectors and socio-economic groups bouncing back while others have struggled and experienced a loss of savings, particularly citizens on lower incomes and those in rural areas. 

“We think there will be more populist policies going forward to drive consumption while infrastructure spending is likely to take a breather”

In India, whenever a coalition is needed to form a government it brings uncertainty and usually a pause in the current long-term policy and that is the case now. With a more fragmented government, policy making in general is going to become more difficult. And given the results of the election, we think there will be more populist policies going forward to drive consumption while infrastructure spending with private capex is likely to take a breather. 

There are strong, long-term drivers in India in terms of demographics, its place in world trade and its rapidly developing industrial and manufacturing capacity. These structural growth agents we think are still intact and in play. However, these areas need a leader with a clear mandate to harness them and drive policy and, therefore, how the coalition government takes shape will be crucial.

What does it mean for Indian equities?

We expect volatility to continue as the next government takes shape. Markets will then likely stabilize, in our view. However, we expect sectoral leadership to change in favor of consumption stocks away from capex-led themes. 

We think capital goods and infrastructure-related sectors spanning industrials and materials will face headwinds in the near term and associated stocks will likely be negatively impacted. There are grey areas like power and defense which should be less affected as these are less sensitive to partisan issues. But it will be consumption-related sectors like consumer staples, traditionally strong areas like  pharmaceuticals, and other areas that may be more favorably looked upon by an evolving coalition that could fare the best in the coming weeks in our view. 

A cognizance for quality by the market, which has been absent for a number of months, should also return, which is a good thing. We do expect likely prolonged volatility in small and mid-cap companies given the elevated valuations of these stocks in recent months and the potential uncertainty around continuity of domestic retail flows into investment vehicles.

What are your other concerns?

Consumption growth has continued to be weak despite strong GDP expansion over the past two years in India. This implies the benefits of economic growth are still not resulting in enough employment opportunities for the lower income groups. For GDP growth to be sustainable, we think consumption growth has to improve going forward. There is also uncertainty around capital gains tax. There could be increases in both short term and long term capital gains taxes, which would likely disappoint overseas investors if that were to happen.

Peeyush Mittal
Portfolio Manager
Matthews Asia

Source: *Bloomberg, 6.4.24