India, the world’s largest democracy with 900 million eligible voters, is currently engaged in one of the most complex voting exercises around the modern democratic world. The sheer logistics of the largest election on earth is, naturally complex; the election is being held in 7 phases, spanning from 11th April to 19th May with the result declaration on 23rd May.
This article analyses the Indian general elections giving a brief history of Indian politics, introducing major political parties taking part, looking at the economic performance of the Modi [current] administration, and laying the factors/policies that investors in the economy must keep a close eye on.
A Brief History
India is a parliamentary democracy, meaning that the political party that secures the most seats in the parliament becomes the ruling party, making its campaign leader the most likely candidate for the position of Prime Minister of India. Political parties, however, conventionally declare the frontrunner for the Prime Minister before the election begins. India held its last general elections in 2014 where Narendra Modi’s Bharatiya Janata Party (BJP) won in a landslide victory, receiving 31.34% of the votes and securing 282 seats at the Lok Sabha (lower parliament), while Rahul Gandhi’s Indian National Congress, India’s pre-eminent political party, received 19.52% of the votes and controlled a meagre 44 seats in the Lok Sabha.
Narendra Modi won the election of 2014 on two broad agendas: to fight the incumbent establishment of Indian National Congress, promising to remove corrupt officials and establishments as an outsider, and to bring massive economic growth, promising millions of jobs to the people living in rural (predominantly) and urban areas.
This section will discuss some of the major policy implementations during the administration’s tenure and their effects on current and future economic prospects. The Modi Administration inherited a worsening Current Account Deficit (CAD) and a volatile rupee. While the administration was not able to deliver on some key promises, majorly missing targets for job growth and increasing manufacturing sector’s share in the country’s GDP, it did move forward with some key bills that will be crucial to Indian economic performance in the long run.
USD/INR evolution; Source: tradingeconomics.com
To begin with, the administration undertook the biggest overhaul of the country’s complex tax system since the country’s independence. The Parliament passed the GST (Goods and Service Tax) Constitutional Amendment Bill in August 2016, allowing replacement of multiple tax layers at the center, inter-state, state, and local with a single, nationwide, value-added tax on goods and services. The GST categorizes various goods and services into different tax slabs and became effective from 1st July, 2017.
While various news journals discussed the well intentioned nature of the bill and its long-term positive benefits, some late decisions on the GST rate structure, classification and variation of goods and services caused confusion amongst businesses and resulted in delayed consumption expenditure by households. According to the IMF India Executive Report (2018), transitional effects of GST implementation contributed to a slowdown in growth to 6 percent (y/y) in the first half of FY2017/18 before bouncing back to levels seen in the chart below.
Source: IMF report, published in March 2019.
After that, Modi Administration’s demonetization policy took the nation by surprise. In an overnight announcement, the Prime Minister declared the country’s two largest denominated notes (Rs. 500 and Rs. 1000), contributing almost 86% of outstanding currency in circulation, void. The move was intended to curb the black economy, increase tax-receipts and curb money laundering. The policy had an adverse impact of the functioning of the economy for its inability to account completely for the fact that majority of the Indian economy was and remains informal, based in rural areas, with little to no access to digital/online banking/payment methods.
Consequently, the policy’s hasty execution, multiple delays in the printing/replacement of new currency, and other logistical problems led to a slowdown in GDP growth in FY 2017-2018. However, according to data submitted to IMF, owing to demonetization and government’s active campaign against tax evasion, the Indian Ministry of Finance estimated that the growth of new taxpayers reached 45.3 percent in FY2016/17, compared to 25.1 percent in the previous fiscal year.
Important Policies on Watch
Despite a few setbacks, the BJP is expected to come back to power, albeit with a lower number of seats in the parliament. In recent months, Narendra Modi’s tough stance on the country’s confrontation with Pakistan over the terrorist attacks on India’s military site (the exact details and nature of the attacks remain disputed owing to different accounts from both sides), India’s successful launch of anti-satellite missiles (giving the country membership to an elite group of countries that possess such a capability), comparatively scandal-free government tenure (exception of military jets scandal with the French government) will help the BJP to pave its way to another victory.
However, from an investment point of view, owing to slightly homogenous economic policies of both major parties, in order to keep the country’s economic base stable and growing, the incoming government has mammoth tasks to accomplish. The following will need to be watched closely and will, according to the authors, play a key role in India’s emergence as a key market for investment and growth.
Non – Performing Loans
According to the Reserve Bank of India (RBI; country’s central bank), the gross non-performing assets in Indian banks, specifically in public sector banks (PSBs), are valued at around Rs 400,000 crore (~US$61.5 billion), which represents 90% of the total NPA in India, with private sector banks accounting for the remainder.
Note: The graph shown above demonstrates the share of Non-Performing Loans in Indian Banks.
To solve the problem, the Government of India is undertaking a significant recapitalization of PSBs to enhance regulatory capital and provide “growth capital” to boost lending to the economy. The two-year recapitalization plan of INR 2.1 trillion (1.3 percent of GDP) was initially announced in October 2017. A subsequent announcement in January 2018 detailed the allocation of 0.5 percent of GDP to 20 PSBs during FY17/18, 59 percent of which was slated for 11 weak PSBs currently under the RBI’s Prompt Corrective Action (PCA) framework. The bulk of the recapitalization in the first year was financed by recapitalization bonds. The total capital injection envisaged is broadly in line with the capital needs estimated by the 2017 FSAP, which ranged from 0.75 to 1.5 percent of GDP.
Another avenue for the sector to release capital would be to fix the stuck Insolvency and Bankruptcy Code (2016). According to critics, the Bankruptcy code has been slow in extraditing cash from stuck-up projects. IBC mandates that an insolvent asset must be resolved in 270 days. If an insolvent asset does not find a buyer within that period or if the committee of creditors, the decision making body on these assets, is not happy with the bids, the asset should be liquidated at the minimum value assessed by the resolution professional managing the asset. According to details released by the Insolvency and Bankruptcy Board of India (IBBI), out of the 1,484 cases admitted for the corporate insolvency resolution process (CIRP), 586 have been closed as of December 2018. That marks a hit rate of about 40%.
The bottom line is that despite efforts to solve the issue, the authors feel that the situation will only worsen before getting better. Most of the public sector banks currently trade at market to book value ratios of around 0.5. Since we expect the incoming government to take catalytic measure to speed up process to kick-start investment in new projects and force banks to book losses, we recommend investors with a short-term horizon to maintain short positions in these banks.
Power generation will play a key role in the country growth story. In May 2018, India ranked 4th in the Asia Pacific region out of 25 nations on an index that measures their overall power (source: ibef.org). As of February 2019, total installed capacity of power stations in India stood at 350.16 Gigawatt (GW). According to government estimates, coal-based power generation capacity in India, which currently stands at 191.09*GW is expected to reach 330-441 GW by 2040. Coal provides about half of India’s commercial primary energy supply today and is the dominant fuel for power production in India.
Source- Government of India: Ministry of Power
Although, in recent years, India has moved from a country for chronic power shortages to a country with near surplus production, investment in coal and renewable energy sources will be a key issue for incoming government. Narendra Modi’s commitment to bring light to every home across the country will require massive investment, both in speed and execution of projects. Despite its increased demand for power from coal, India is projected to meet its commitments under the Paris Accords. Modi Administration’s Deen Dayal Upadhyay Gram Jyoti Yojana (DDUGJY) and Integrated Power Development Scheme’s (IPDS) have boosted the process of electrification throughout the country. According to India Brand Equity Foundation, the country is expected to attract investments worth INR 11.56 trillion (USD 165 billion approximately) between 2017-2022 in thermal, hydro, nuclear and renewable segment.
Source- Government of India: Ministry of Power
India is a major importer of crude oil for its energy needs. According to Economic Times, rupee depreciation and crude oil price volatility is expected to push its total import bill higher by 42% to $125 billion or Rs 881,282 crore in the current financial year ending March 2019. According to the same source, in volume terms, the country’s crude oil imports are set to rise 3.72 per cent to 228.6 MT in the current fiscal from 220.4 MT last financial year.
While we do not recommend to buy/sell any company in the Indian energy sector, we do want to point to towards the importance of keeping track of investment and developments in respective sector, for not only do they ensure smooth functioning of manufacturing sector, but also play an important part in connecting millions of Indians to the global economy.
Current Account Deficit and Foreign Reserves
Due to volatile oil prices and currency, the country’s CAD remain under close scrutiny. Narendra Modi’s government’s FY 2018/19 budget envisages a reduction in the headline fiscal deficit with an increase in net revenues as a share of GDP (roughly half from an increase in direct tax collections).
Two allocations under the current government’s budget remain unfunded while playing crucial roles, directly or indirectly, in the election manifestos of both parties. These are, namely, to offer farmers a MSP (minimum sales price) of 1.5 times production cost and the launch of a flagship national healthcare scheme to cover 500 million potential beneficiaries (about 100 million households) with the establishment of a dedicated Affordable Housing Fund (0.2 percent of GDP, financed mostly off-budget). Details of the aforementioned policies are yet to be finalized and must be watched closely.
For the reader alien to Indian politics and economy, we feel that it is important to mention that public opinion is highly influenced by food prices and the agricultural sector in general. Depending on the nature of the source, as of 2017, 45% – 48% of the Indian population was still employed in the primary sector. Small farm holdings, lack of country-wide irrigation infrastructure, and dependence on cyclical monsoon have historically resulted in bad crops and financial woes for small time famers across the country. This often leads to the governments making/granting loan waivers to gain popularity, putting a heavy burden on the Exchequer.
Due to similar reasons, the states’ share in aggregate fiscal deficits and debt is large, and spending pressures pose risks. These include farm loan repayment waivers, the UDAY scheme under which states take over part of electricity distribution companies’ debts and losses in return for reforms, and the recommendations of the Seventh Pay Commission. While states’ fiscal deficits have generally been within 3 percent of GDP, stipulated under states’ self-imposed fiscal rules, they have risen recently.
While no political party has promised schemes that would blow the targets for CAD, an evolution of policies in the respective fields will be crucial. According to a monitoring report, IMF (2018) noted that continued fiscal consolidation would be needed to reduce public debt. It stressed the need to take advantage of the projected acceleration of growth to achieve a public debt level of 60 percent of GDP by FY2022/23, as also recommended by India’s Fiscal Responsibility and Budget Management Review Committee. The current level of debt/GDP is above 70%.
As both political parties have promised (for some time now) increasing investment (domestic and foreign) to create the much needed 1 million (number remains disputed), it is essential to follow how the incoming party will work around easing the business and investment regulations in the coming years. While under the Modi Administration India moved quite a few places up in the ease of doing business index, India’s average most favored nation applied tariff rate (at 13.4 percent as of 2016) is higher than in some peer countries (though with relatively large differentiation between agricultural and non-agricultural products). Additionally, tariffs are changed frequently, including the FY2018/19 budget.
In recent years, the United States has challenged India’s export subsidy schemes at the WTO. They argue that the country has crossed the income threshold above which a country becomes subject to the prohibition on export subsidies.
On the other hand, the government’s evolution and support in developing a digital telecommunication infrastructure to connect more people from rural and urban areas will achieving constant growth rates above 7%. Countries with deeper levels of financial inclusion – defined as access to affordable, appropriate financial services – have stronger GDP growth rates and lower income inequality.
According to Brooking Institution, under Modi’s Pradhan Mantri Jan Dhan Yojana (PMJDY), the number of adults having bank accounts increased from 53% to 80%. Despite the tremendous achievement, reliance on non-institutional credit agencies by rural households was as high as 44 percent in 2012 as per the All-India Debt and Investment Survey (AIDIS) and remains relatively high even today.
While late last year, the ruling Bharatiya Janata Party (BJP) lost power in three key states, handing Prime Minister Narendra Modi his biggest electoral defeat since he took office in 2014, the baseline expectation is that the BJP will win.
While India’s economic growth slowed in the most recent quarter of released data, RBI’s rate cuts is expected to boost consumption and lending. According to literature, elections in the Indian markets do not affect the stock market to the extent as they do in Western counterparts. The markets do, however, exhibit high volatility in the immediate month post-election results. Given BJP’s expected win, the Sensex (main market index), is predicted to keep its positive momentum and we recommend investors to take advantage of volatility and positive momentum. Since the banking sector remains the only major avenue for credit growth and infrastructure, solving the NPL problem will be a key policy for the incoming government spending. For long-term investors with stronger appetites, we recommend to buy the PSB stocks which currently trade far below value.