A recent trip to the most populous swing state, Uttar Pradesh, to take the current political pulse reminded us of some humbling lessons in this vast country.
- Social class, ethnic /caste and religious background still matter very much in this vibrant democracy.
- This diversity translates to political divisions across many lines,1 making it very hard to guess how various local alliances among smaller parties could translate to poll results.
- A general anti-incumbency vibe is palpable and could undermine the vote share of the ruling Bharatiya Janata Party (BJP)-led coalition in favor of a more united opposition. The country’s first-past-the-post ballot system, however, makes election math from vote share to seat share not a straight line.
- Alliances are not immutable and could easily shift before or after the vote count.
Missing a crystal ball, we focus our attention on trends that are likely to prevail regardless of the election outcome.
Competitive populism poses fiscal risks. India’s debt levels are high compared to peers and fiscal consolidation, which had been proceeding, though slowly since 2014, is now clearly on hold. A lull in the fiscal consolidation trend can perhaps be excused because it is an election year and because of teething problems of a Goods and Services Tax (GST) that went into effect in 2017. A deliberate policy reversal, however, would undermine macroeconomic stability and investor sentiment. Promises of universal farm loan waivers, minimum income to the poor, and lower GST taxes for smaller traders are already popular topics in the opposition’s political discourse, and are likely to remain in the political agenda even after the elections. The ruling-party BJP is not immune to these pressures, and is providing cash transfers to farmers and middle-income tax cuts, timed to come right before elections. In short, medium-term fiscal risks are on our minds.
Reform momentum may be waning. Following the 2013 Taper Tantrum, India was at the forefront of the Fragile Five in instituting reforms, which included a new bankruptcy code, the recapitalization of state-owned banks, reductions in subsidies, food supply reforms, and the introduction of the GST, as well as improvements to the governance structure of the Central Bank and the ease of doing business in India. These reforms paid off in macroeconomic stability and lower inflation.
With lower oil prices, the country’s current account deficit is also more manageable, which reduces pressure on the Indian rupee. Despite implementation delays with the bankruptcy code and recent problems at some non-bank financial institutions, we see the financial sector gradually turning the corner, with the impact of India’s 2016 demonetization behind us. Growth has been waning lately on the back of these problems as well as weaker rural incomes, but we see it recovering in the second half of the year once election uncertainty is over.
More Action Is Needed
Despite a short-term recovery in growth, some key challenges in India await bolder steps. At the top of the list is job creation for India’s young population, which can only realize its economic value if properly employed. Besides labor and land reform, judicial and administrative reforms are needed to get this economy firing to create the jobs it needs, especially in manufacturing. None of these reforms are easy or popular.
Current polls suggest that, even if a BJP-led majority were to emerge, it would likely require more coalition partners to find a parliamentary majority. Of course, this risk may already have diminished significantly with the recent skirmish between India and Pakistan, which has bolstered Prime Minister Narendra Modi’s popularity. Other possible outcomes are a Congress2-led coalition or a third front government formed by regional parties, including the Congress. We do not see a strong mandate for structural reforms coming out of any of these scenarios.
This is not to say we expected India to be emerging as fast as China did, considering its solid democratic values in a vastly diverse geography. Reforms in India often take years to debate before a consensus appears. Nonetheless, the momentum for reforms may be waning and valuable time may be lost in the process.
We will be watching the election results closely. Until more clarity emerges about the direction of policies, we favor curve steepeners on the back of recent fiscal slippages, a more dovish central bank, and emerging medium-term fiscal risks.
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