India's Election Outcome Sets Stage for Stable, Pro-Investment Government

The clear electoral mandate given to the Bharatiya Janata Party (BJP) and its prime-ministerial candidate Narendra Modi in India's elections reduces political uncertainty and raises the potential for economic policy reform, says Fitch Ratings.

Fitch Ratings says the BJP will be the first party in India since 1984 to govern with a majority of seats in the Lok Sabha (lower house of parliament). This gives the new government a level of stability to enact its policy agenda that did not exist under the previous coalition administration. The strength of the BJP's mandate will be reinforced by the particularly weak outcome for the incumbent Congress party, which fell to 44 seats from 206 - its worst result ever.

Modi’s reputation as a pro-business politician with a strong administrative record is positive for investor sentiment. According to Maplecroft, the new BJP-led government will seek to implement greater economic liberalisation in a bid to attract foreign investment. It will also be able to cut red tape, notably for the clearance of investment projects.

"On the whole, investors have been appreciative of the support that Modi’s government gave them in starting business operations in Gujarat when he was chief minister of the state. One mechanism through which a Modi government could replicate cuts in red tape at the national level would be to reduce the amount of environmental regulation associated with project approvals," says Maplecroft in its Post-Election Monitor – India.

Yet the details and implementation of any policy agenda remain uncertain. The government's first budget, likely to be released in July, will be a key indicator of Modi's priorities and legislative agenda.

Fitch says India is facing a number of economic challenges - including a significant deceleration of growth, a wide fiscal deficit, and persistently high inflation. The most salient of these issues from a sovereign credit perspective is the need to re-boost the sustainable growth rate. This will require a re-acceleration of the investment cycle, which has been hindered in particular by stalled infrastructure projects.

Clearing the bottlenecks of infrastructure projects is likely to be an early priority. However, sustaining the investment cycle over the long run will require a broader improvement in the business environment. Structural reforms related to governance, and the reduction of red tape, are essential to re-accelerating economic activity.

Notably, India ranks low relative to its 'BBB' range peers on the World Bank's Governance Indicator (48th percentile versus a a 'BBB' median of 55) and Ease of Doing Business Indicator (28th percentile versus a 'BBB' median of 71).

The government will be constrained from spurring growth through fiscal stimulus, owing to the wide fiscal deficit and high general government debt load. Both the general government budget deficit (-7.3% of GDP) and gross general government debt load (64.7% of GDP) are much higher than 'BBB' category medians (respectively -2.5% of GDP and 40% of GDP). As such, a clear strategy for fiscal consolidation based on structural measures - rather than one-off measures such as deferrals of plan expenditures and bill payments - would improve fiscal credibility. In particular, the establishment of a policy framework to achieve the goals of the Fiscal Responsibility and Budget Management Act, which calls for a deficit of 3% of GDP by FY17, would be credit positive.

Establishing a low-inflation environment would also be supportive of macroeconomic stability and growth. The Reserve Bank of India has already sharpened its focus on inflation, as illustrated by policy rate hikes; and the recent Urjit Patel Committee report has recommended several changes to the monetary policy framework, including CPI-inflation targeting, which are in the government's purview. Government policies to reduce food price growth will also be key for reducing the structural drivers of inflation.

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