Capex And Fiscal Strategy Remain Resilient Post BJP Election Setback, Economists Say

India's gross domestic product growth is likely to remain resilient, with the government's thrust on capex and fiscal consolidation continuing despite a lack of clarity on the election outcome.

While the BJP lost the majority and the BJP-led coalition secured fewer votes than was expected, the base case remains that the BJP will now form a coalition government, and despite the ongoing uncertainty, India's medium-term growth outlook is likely to remain intact.

However, in the past, the largest winning party has seldom gotten over 200 seats and still formed stable coalitions, many of which have undertaken important reforms, HSBC said in a note. In fact, consultative processes that include coalition partners can sometimes make possible far reaching reforms such as the 1991 reforms, Pranjul Bhandari, chief India economist at HSBC, said. And a strong opposition can perhaps be better for checks and balances.

"We still expect some ‘easy’ reforms that the Modi government has been spearheading (e.g., the public capex thrust) to continue, which generates our base case of 6.5% growth potential," Bhandari said. Interestingly, most of these reforms were via executive action, so a slower legislative process may not impact them immediately. Welfare spending could rise, but that can coexist with gradual fiscal consolidation as tax growth is strong. Moreover, the economy appears to be in good shape in terms of growth and stability. 

Will the pace or direction of reforms slow or change?

"Our view is that this is unlikely," Ridham Desai, equity strategist at Morgan Stanley, said. Most of the likely reforms in the coming five years are in the arena of execution rather than law changes, Desai said.

Will the focus on macro stability, which has driven down inflation and asset market volatility, inform government policy change?

According to Desai, the basic case is that the BJP-led NDA government is unlikely to sacrifice macro stability as its anchor to economic policy.

The political outcome suggests weak sentiment at the lower end of the income pyramid, as stated in a research note by UBS. "To help broaden India's growth, we believe India needs a broad-based recovery in the capex cycle as construction is the largest generator of jobs outside of agriculture," Tanvee Gupta Jain, an economist at UBS, said.

While political stability should help ensure continuity in policy agendas, there is a risk of populist bias in the third term, targeted at lower income strata, and a change in economic policy dynamics with tougher reforms pushed further out, according to UBS.