Blog

India’s Post‑Election Outlook: A Fine Balance

A new round of reforms could help maintain the delicate balance between growth and financial prudence.

As Indians cast ballots in a general election that ends 19 May, we think it’s a good time to take stock of the investment outlook. The election outcome could prove pivotal to global growth as well as India’s.

Prime Minister Narendra Modi’s government has initiated important structural changes that are likely to help sustain high growth rates over the next several years. However, to ensure that risks to the banking system and fiscal sustainability don’t resurface, we think the next government will need to embark on a second generation of reforms.

We believe the National Democratic Alliance, led by Modi’s Bharatiya Janata Party (BJP), would be more likely than the opposition United Progressive Alliance (UPA) to resist populist policies that could jeopardize fiscal sustainability and growth.

While both alliances have espoused populist policies in the current campaign, the BJP since 2014 has avoided the legislative paralysis seen in the preceding UPA government. The BJP’s implementation of demonetization and a value-added tax has weighed on demand, but nonetheless goes some way toward shoring up the medium-term outlook and, at least as importantly, creates a single internal market for goods and services by eliminating tariffs on trade between states for the first time.

A fine balance between growth and prudence

Despite the reforms to date, India has yet to see a material GDP growth dividend as growth slowed in the wake of the tax reform and demonetization to below the perceived trend rate of around 8%. Accordingly, ahead of the competitive general election, the authorities have eased both fiscal and monetary policy in an effort to stimulate growth. Bank credit has already begun to recover following signals from the Reserve Bank of India (RBI) that the asset quality review started in 2015 has ended.

The recent easing in financial conditions marks a welcome respite from the shocks of the government’s demonetization in 2016 and last year’s liquidity crisis in the nonbank financial sector, but the delicate balance between growth and financial prudence needs to be maintained.

We believe the following specific reforms could help keep that balance:

  • The government could affirm its commitment to a fiscal consolidation path after recent slippage.
  • The RBI could reiterate its commitment to the inflation-targeting framework implemented under former Governor Raghuram Rajan. Incumbent Governor Shaktikanta Das appears to have tilted the balance of the RBI’s dual mandate in favor of growth.
  • The government could continue consolidating state-owned banks and avoid further backpedaling on the 2016 Insolvency and Bankruptcy Code, which was designed to enhance the rule of law and help banks recover losses when corporations default.
  • The RBI should also carefully manage the still-delicate funding risks of the nonbank financial sector, which continues to face higher funding costs despite two consecutive rate cuts by the RBI.
  • To address the persistent weakness of investment demand, especially in manufacturing, we believe policy needs to focus on easing regulation as a means to boost export competitiveness and ultimately improve external balances.
  • Additional reforms to the agriculture sector could serve to increase productivity growth and boost rural wages.
  • Further efforts to develop local capital markets, including the gradual opening of the domestic fixed income market and eventual inclusion in benchmark bond indices, would help to sustain the high domestic savings rates and indeed to mitigate current account deficits.

Constructive outlook

Although “Modi-phoria” has waned since the election in 2014, the current government has been successful in improving India’s secular growth outlook. A second term would likely start with lower expectations than the first, but with reasonable odds of further reforms to consolidate and build on recent achievements.

In external credit, we remain constructive on selected fundamentally sound companies in the financial, energy, and infrastructure sectors. Financials, in particular, stand to benefit from easier liquidity conditions and a more accommodative regulatory stance. We remain neutral on the rupee given the looser monetary policy stance and the potential shift in the RBI’s focus to a more growth-oriented framework.

While the BJP is projected to win the election, we recognize that the predictive power of Indian election polls has been poor in the past. In the event of a surprise upset by the UPA, we would expect a period of uncertainty that would unsettle Indian asset prices, with the currency serving as the primary shock absorber. Even then, however, we believe that the reforms of the past five years provide a strong anchor for Indian external credit.

For more on India and other emerging markets, please see “10 Investor Takeaways From the 2019 Spring IMF World Bank Meetings.

READ NOW

The Author

Gene Frieda

Global Strategist

View Profile

Latest Insights

Related

Emerging Markets

Explore PIMCO’s Emerging Market solutions and learn how our EM team builds portfolios with active positioning that seeks to reduce traditional EM risk while maximizing potential returns.

Disclosures

London
PIMCO Europe Ltd
11 Baker Street
London W1U 3AH, England
+44 (0) 20 3640 1000

Dublin
PIMCO Europe GmbH Irish Branch,
PIMCO Global Advisors (Ireland)
Limited
3rd Floor, Harcourt Building 57B Harcourt Street
Dublin D02 F721, Ireland
+353 (0) 1592 2000

Munich
PIMCO Europe GmbH
Seidlstraße 24-24a
80335 Munich, Germany
+49 (0) 89 26209 6000

Milan
PIMCO Europe GmbH - Italy
Corso Matteotti 8
20121 Milan, Italy
+39 02 9475 5400

Zurich
PIMCO (Schweiz) GmbH
Brandschenkestrasse 41
8002 Zurich, Switzerland
Tel: + 41 44 512 49 10

PIMCO Europe Ltd (Company No. 2604517) is authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963), PIMCO Europe GmbH Irish Branch (Company No. 909462), PIMCO Europe GmbH UK Branch (Company No. BR022803) and PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 15 of the Securities Institutions Act (WplG). The Italian Branch, Irish Branch, UK Branch and Spanish Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority; and (4) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication.| PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2) . The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser.

All investments contain risk and may lose value. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Currency rates may fluctuate significantly over short periods of time and may reduce the returns of a portfolio. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Investors should consult their investment professional prior to making an investment decision.

10 Investor Takeaways From the 2019 Spring IMF/World Bank Meetings
XDismiss Next Article