Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

Elections, economy and markets

As the market is waiting for a change of government, it probably needs to contain its expectations

The stage is set for one of the most interesting electoral battles in the history of independent India. The country will vote in April-May to elect its 16th Lok Sabha, which will pave the way for the formation of a new government at the centre. Voting will happen at a time when, for the first time since the beginning of reforms, the economy will grow under 5% for the second consecutive year. Further, the consumer price inflation has been above the level of comfort for at least four years now and India narrowly avoided some serious trouble on the external front in 2013. Things have improved on the external account, but investments and growth outlook remain weak. In the given backdrop, it is being widely argued that economic issues will dominate the elections.

If the stock market is to be believed, which is known for discounting the future in advance, India is likely to get a stable and a business-friendly government in May. The market seems to be factoring in, though not for the first time in the past few months, that the Bharatiya Janata Party (BJP)-led National Democratic Alliance (NDA) will form the next government at the centre. However, it is important to note that electoral outcomes in India are not always in line with the script written by opinion polls. Also, we do not have strong enough evidence, at least in the general elections, to suggest that economic performance plays such an important role that it can dislodge the incumbent. Differently put, it may not be the prime driving factor for the next government either.

It is argued that the Congress-led United Progressive Alliance (UPA) came back to power in 2009 with a bigger mandate because of better economic performance during its first tenure. If this is indeed true and economic performance is responsible for electoral outcomes, then what is the explanation for NDA’s defeat in 2004? In fact, the government was so confident about its own performance that it called for early elections and went to the electorate with the slogan of “India Shining". When the NDA demitted office, the gross domestic product (GDP) growth rate was 8% and the consumer price inflation was under 4%.

Also, it is difficult to argue that economic outcomes would have been vastly different in subsequent years if the NDA was voted back to power in 2004. The Congress party itself lost power and a significant amount of vote share in the 1996 elections after having formally introduced economic reforms while in office during 1991-96, which led to higher growth in later years. Therefore, it is difficult to argue that economy is the only factor or even the most dominant factor in general elections. If economy is indeed such a big factor, UPA-II, despite its disappointing performance in the recent years, will still be posting an average growth that will only be lower than its own record in the first term.

To be sure, there are many factors that influence voting in a diverse country like ours and by giving too much weight to economic outcomes, one runs the risk of oversimplifying matters. Since there isn’t strong enough evidence to suggest that economic growth and reforms-oriented policies lead to favourable electoral outcomes, the government of the day would always lack the incentive to push policies that are perceived to be politically sensitive, such as cutting expenditure on various subsidies or introducing greater market-oriented policies.

The BJP-led NDA, which the market is expecting will come to power, will also have with it the memories of losing an election under the India Shining slogan and, therefore, will probably be reluctant to pursue market-orientated policies. So, it is important that investors anchor expectations to realistic levels.

Also, if it comes to power, the policies of NDA will depend on the final composition of the alliance. Furthermore, it is important to note that BJP, while in opposition, did not make much effort to resist populist policies of the UPA. Arvind Panagariya of Columbia University, in a recent article, summarized its position as, “It (BJP) went on to vote for nearly every populist bill UPA brought to the floor of Parliament without stopping to think that it, and not UPA, might have to live with the consequences. But now that the chances of a (Narendra) Modi victory look bright, it will find out how it has shot itself in the foot." (See: UPA hurts India as it exits, The Times of India, 11 March.) Therefore, a lot of effort will be required on the part of the government to bring back investments and growth on track. Economic environment may not change immediately after the formation of a new government, though sentiments will turn positive, at least in the short run.

End note: As the market is waiting for a change of government at the centre, it probably needs to contain its excitement and expectations. Even if NDA comes to power, as is widely expected, it may not lead to a major shift in the policy framework. This columnist recently had the opportunity to attend a session in the capital where BJP’s prime ministerial candidate, Narendra Modi, spoke about economic issues. The crux of the speech was that the BJP is not looking at a major overhaul of economic policy, but will look for small changes that would lead to better outcomes. Modi also argued that governance is more important than policy.

More details will perhaps emerge as we move closer to elections, but as of now, it appears that the party is not working with too many big ideas that will quickly push India back to the higher economic growth path. Bulls take note.