First glance

India’s indecisive election result could point to slower economic reform

India’s new coalition government will have to make more compromises, including on the economic front

Publishing date
06 June 2024

India’s elections that concluded on 1 June did not deliver the expected landslide victory for Prime Minister Narendra Modi and his Bharatiya Janata Party (BJP). The BJP lost its majority in parliament, meaning Modi must work in a National Democratic Alliance (NDA) with two smaller parties whose leaders are known to switch sides often.

For Modi, an NDA government will not be as easy to run as a BJP government with control of the parliament. Consequently, the markets reacted very negatively to the election results, though this reaction has been toned down as the outlines of an NDA coalition have become clearer.

Modi has already been in power for ten years, time he has used to improve India’s balance sheets on two fronts: the current account and fiscal balances. First, on the external front, India is now much less prone to shocks, as its current account deficit has been reduced substantially. However, India’s greater resilience comes not from stronger exports but from weaker imports, notwithstanding the booming economy. This is mainly due to import substitution: domestic products are shielded from foreign competition by high tariffs and expanding industrial policy. This resembles much more Latin America in the 1970s than China after its entry into the World Trade Organisation, when import tariffs were slashed to facilitate the entry of foreign manufacturers and, with them, technological transfer and improved business practices.

Modi’s timid trade liberalisation is one of the main reasons why foreign direct investment into India, especially in manufacturing, has remained underwhelming. Under a coalition government, it seems hard to believe that trade liberalisation will speed up, and that local industrialists and trade unions will be less powerful than so far.

Meanwhile, developed economies, especially the US but also the EU, are looking to de-risk their links with China. India is an obvious alternative, given the size of its population and market potential. India’s geopolitical tailwinds are there to stay but investors will want to see more opening up before they jump into the Indian market, especially since many have already gone through a rather negative experience, in terms of market access, with China. 

Second, on the fiscal front, Modi has somewhat improved India’s position although the deficit remains large. The most important achievement was the introduction of a goods and services tax, in place since 2017. The larger fiscal revenues this triggered have mostly been used for public investment, especially in infrastructure. With a coalition government, however, Modi might have no choice but to increase welfare programmes, reducing the room for public investment. Given the amount of investment India needs to reduce its infrastructure gap, this is clearly a problem down the road.

Finally, the election results showed how important it is for a large and labour-intensive country like India to create manufacturing jobs. India has done very well in the information technology sectors, but this job creation is only for the most-skilled workers, leaving many others behind. To create the necessary jobs to double India’s income in the next twenty years, labour-intensive manufacturing will be needed. Governing in coalition will only increase the problems that Modi had already been facing in his first two mandates.

Given these factors, it seems safe to expect much slower economic reform in India and lower potential growth. Still, given the fact that India is the only country big enough to enable the reshuffling of supply chains away from China, the international attitude towards India is expected to still be positive, despite the less-clear reform path.

In conclusion, India’s election results do not bode well for economic reform, but they have shown the resilience of India’s democracy. For Europe, the former is not good news, but the latter clearly is. The European Union needs a strong Indian economy for its exports and as an alternative to China for its manufacturing FDI. This prospect is now more distant. But exactly because of this, India might be more willing to strike a trade deal with the EU at a time of major global uncertainty and great-power competition between the United States and China.

An EU-India trade and investment deal would be extremely important for both as it would offer EU companies access to a very large and growing market and would also offer India more manufacturing FDI from Europe. European Free Trade Association (EFTA) members and India have already signed an agreement involving a $100 billion investment commitment from EFTA members. The EU could be next, especially as Modi’s new government is even more desperate to create jobs.

About the authors

  • Alicia García-Herrero

    Alicia García Herrero is a Senior fellow at Bruegel.

    She is the Chief Economist for Asia Pacific at French investment bank Natixis, based in Hong Kong and is an independent Board Member of AGEAS insurance group. Alicia also serves as a non-resident Senior fellow at the East Asian Institute (EAI) of the National University Singapore (NUS). Alicia is also Adjunct Professor at the Hong Kong University of Science and Technology (HKUST). Finally, Alicia is a Member of the Council of the Focused Ultrasound Foundation (FUF), a Member of the Board of the Center for Asia-Pacific Resilience and Innovation (CAPRI), a member of the Council of Advisors on Economic Affairs to the Spanish Government, a member of the Advisory Board of the Berlin-based Mercator Institute for China Studies (MERICS) and an advisor to the Hong Kong Monetary Authority’s research arm (HKIMR).

    In previous years, Alicia held the following positions: Chief Economist for Emerging Markets at Banco Bilbao Vizcaya Argentaria (BBVA), Member of the Asian Research Program at the Bank of International Settlements (BIS), Head of the International Economy Division of the Bank of Spain, Member of the Counsel to the Executive Board of the European Central Bank, Head of Emerging Economies at the Research Department at Banco Santander, and Economist at the International Monetary Fund. As regards her academic career, Alicia has served as visiting Professor at John Hopkins University (SAIS program), China Europe International Business School (CEIBS) and Carlos III University. 

    Alicia holds a PhD in Economics from George Washington University and has published extensively in refereed journals and books (see her publications in ResearchGate, Google Scholar, SSRN or REPEC). Alicia is very active in international media (such as BBC, Bloomberg, CNBC  and CNN) as well as social media (LinkedIn and Twitter). As a recognition of her thought leadership, Alicia was included in the TOP Voices in Economy and Finance by LinkedIn in 2017 and #6 Top Social Media leader by Refinitiv in 2020.

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