As the Hindi saying goes: If you live in the water, don’t make an enemy of the crocodile.
The ruling party in India, the BJP, was defeated in the Bihar state assembly elections. The party came out with 59 seats out of 243, down 35 seats from the previous elections and considerably worse than expected. Many were looking at the Bihar elections as a referendum of sorts on Modi’s first 17 months in power.
Much of the debate in Bihar revolved around the national debate over Modi’s perceived hard line against Muslims and political dissent, made even more salient by the death of four Muslims supposedly attacked by mobs of Hindus. Now the poor results will set the tone for the multiple subsequent elections that will follow, emboldening the opposition and raising serious questions about the BJP campaign strategy. Perhaps Modi will soften up his tone and sound more conciliatory towards the Hindu-Muslim tensions, but it may be too late to reshape his image.
More objectively, regional elections matters because the composition of the state assemblies will determine party representation in the Rajya Sabha, the Upper House. And it’s there that the government is being blocked by the opposition. Now the focus turns back to implementation – the age old problem in India. Despite good intentions, it’s becoming harder to see how Modi will be able to push through his reformist agenda. Recent defeats have included the nationwide goods and services tax and land reform.
All that said, India still has a few positives going for it. Rajan at the helm of the central bank will continue to be a solid anchor for the country’s macroeconomic management and banking sector reform. Oil prices at these levels are very favourable for the country’s external account. The election results are not enough to completely counter our relatively favourable view, but it certainly curbs our enthusiasm. At the very least, it means that Modi will have to spend more time and energy on campaigning and less on pushing economic reforms. It also may mean that he will have to refocus his priorities towards addressing social tensions.
Indian assets prices reacted accordingly, but INR suffered the most. After opening down 2.3%, the Sensex recovered to close down only 0.5%. Local swap rates were up as much as 12 bp, back to levels seen in late September, undoing the fall in yields that followed the more-aggressive-than-expected 50 bp cut by the RBI on September 29. USD/INR gapped higher to 66.45 – less than 1% from September highs and 3.5% from September 2013 all-time highs.
By Ilan Solot