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Andy Mukherjee, Columnist

Why India’s Political Reset Isn’t a Growth Killer

Coalition governments were the norm for 25 years before Narendra Modi’s arrival. Investors need to get used to them again.  

The era of single-party control is over.

Photographer: Dhiraj Singh/Bloomberg

The spike in volatility in Indian markets this week portends the triumph of politics over economics after a 10-year hiatus.

Narendra Modi met leaders of the parties that make up his National Democratic Alliance Wednesday. For the first time since he became chief minister of the western state of Gujarat in 2001 — or prime minister in 2014 — he needs allies to stake his claim on power.

Right up to Monday, zooming asset prices were signaling a comfortable victory for Modi. Not only was the muscular Hindu right-wing leader going to return for a third term, his mandate might even allow him to change the constitution. When votes were counted Tuesday, markets had a heart attack. Forget turning the secular republic into a Hindu nation, his Bharatiya Janata Party, or BJP, doesn’t have the numbers to form a majority government. Modi will only head a coalition administration, for which he may be temperamentally unsuited.

Voters couldn’t care less about his discomfiture, or for the volatility in financial markets. They want a toning down of BJP’s religious polarization and an emphasis on pro-labor policies: more jobs and better incomes. Without those, 8%-plus economic growth is an empty slogan.

For providers of capital, though, Modi’s shrinking halo is far from good news. India’s risk premium is lower than most other emerging markets. Don’t be surprised if that premium — the extra return investors expect for their additional risk — goes up.

But don’t be too alarmed, either.

Two Tumultuous Periods, A Decade Apart

Investors had all but written off domestic political risk in India before this election

Source: Bloomberg

The last time politics played such a big role in Indian markets was in the winter of 2013. That was when S&P Global Ratings was threatening to cut India’s credit appraisalBloomberg Terminal to junk unless elections the following year produced a government capable of reviving growth, which had slumped to just over 4%, the slowest in a decade. “Politics are trumping economics,” Goldman Sachs Group Inc. wrote in a note to investors.

Back then, voters perceived their interests to be in sync with investors. In giving the BJP a full majority of its own in 2014, they ended a 25-year-long era in which coalitions — some stable, others not — were the norm. In 2019, Modi won an even bigger mandate. All that changed the assessment of the country’s riskiness. The cost of hedging against a default on $10 million in Indian bonds1 fell from $300,000 a year in November 2013 to less than $50,0000 now.

When financial honchos like JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon applaud Modi for doing an “unbelievable job,” they cite tangible gains, such as the explosion of a smartphone-based digital economy or the visible improvement in infrastructure: roads, ports, airports. What they really love him for, though, is that he took party politics out of the political economy and narrowed India’s risk premium.

What Risk?

Narendra Modi has made India safe for investors, as reflected in a decade-long slide in the credit default swap, or CDS, spread on 5-year sovereign debt

Source: Bloomberg

But he did that in ways that pitted capital against labor. In Modi’s India, workers lost more of their already-limited bargaining power. A handful of capital-guzzling conglomerates edged out millions of small firms, leading to a surge in income and wealth inequality to levels worse than under British Raj before 1947.

Voters want a reset, but not investors. Publicly they worry about a slow pace of reform under weak administrations. But that isn’t the full story. Even Modi — with all power concentrated in him — has failed to execute controversial changes in land and labor markets. In reality, a dependence on allies brings back memories of the $23 billion telecom scandal of 2012, followed by an alleged $42 billion coal scam under a previous Congress Party-led coalition government.

Those concerns would be rational if corruption did ever go away under the strongman’s rule. Only the threat of discovery disappeared, as independent institutions were emasculated. For six years, the Modi government ran a system of anonymous corporate financing of elections riddled with allegations of quid pro quo. It was only in February that the Supreme Court finally declared the mechanism unconstitutional and forced disclosures. Even then, Modi and his ministers defended the so-called electoral bonds as a move toward transparency. His finance minister vowed to bring them back.

That was before the poll verdict. Which ally would now allow the BJP to get away with a lion’s share of corporate donations? There’s really no reason for investors to feel too pessimistic if Modi’s diminished clout reins in BJP’s exorbitant money power — fancy new real estate across the country and 10 times as much in general funds as the Congress Party, its closest rival.

Coalitions aren’t always bad. Before Modi scrapped the 92-year-old tradition, India’s railway network had its own separate budget. Heading up the ministry was a coveted job, given to an important partner. “Lalu goes to Harvard,” was the headline of a 2006 Times of India article about Lalu Prasad Yadav, a rural leader from Bihar, one of India’s most impoverished states, who had turned around the finances of railways without raising fares. The transformation was to be a Harvard Business School case study.

Under Modi, the rail network has been run by an accountant, and a former investment banker. The current minister is a Wharton MBA who has never fought a popular election. And yet, India is still waiting for the kind of high-speed connectivity that has reshaped China’s economic landscape. Most ordinary people can’t afford the glitzy new trains Modi likes to flag off on ill-maintained existing tracks. Overcrowding has made regular journeys intolerable. The youth complain about lack of railway jobs.

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A strong government packed with technocrats does not necessarily produce better outcomes than a weak one that must accommodate career politicians. Modi 3.0 will be the latter type. According to media reports, Chandrababu Naidu, a politician from the southern state of Andhra Pradesh, is bargaining for two cabinet posts as the price for his 16 lawmakers to not switch sides. The BJP has 240 of its own. For a majority government it needs 272. With 12 seats, Modi’s other key ally is Bihar’s Nitish Kumar. He, too, will have his demands.

Investors would gain nothing by being too antagonistic to coalition politics. After all, if voters in the world’s largest democracy want the needle of economic distribution to move a little away from capital and toward labor, then so be it. An increase in the risk premium is acceptable if the end result is more widespread prosperity. India’s political reset may be nerve-racking, but not necessarily a catastrophe.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services in Asia. Previously, he worked for Reuters, the Straits Times and Bloomberg News.
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