India: Political storm gathers – Nomura

A series of political developments over the last few weeks has placed the ruling Bharatiya Janata Party (BJP) on the back foot: its key ally has left the coalition and is attempting to introduce a no-confidence motion against the government; it has lost two key by-elections in Uttar Pradesh and rival opposition parties are joining hands, points out the research team at Nomura.

Key Quotes

“The immediate political threat is trivial as the BJP coalition still has a majority in the lower house. However, the emerging political vulnerabilities are emboldening both opposition parties and the more vociferous of its allies to become more restive. A ‘Grand Coalition’ of opposition parties to challenge the BJP in the general election seems likely.”

“An early general election in Q4 2018 (instead of the scheduled Q2 2019) cannot be ruled out. We would assign a 25% probability to an early general election, clubbed together with state elections scheduled in Q4 2018 and H1 2019, including the key BJP states of Chhattisgarh, Rajasthan and Madhya Pradesh. For the BJP, the advantage would be an ease of campaigning and subduing anti-incumbency in states like Rajasthan.”

“From an economic perspective, this suggests that big-ticket reforms are less likely and a populist overtone is more likely as the government raises its pro-farmer, pro-common man profile via higher minimum support prices (MSPs) and fiscal transfers that ensure that MSPs are effective, increasing both inflation and fiscal risks. Given an already negative basic balance of payments (current account + net FDI), this could make current account deficit financing difficult.”

“Overall, the outcome of the Lok Sabha elections are hard to forecast, but political uncertainty and noise is only set to rise in the next year and some consideration needs to be assigned to the opposition parties performing better than in 2014. We believe that these political risks are currently under-priced.”

“INR strategy: INR continues to face challenges from global monetary policy uncertainty and local idiosyncratic developments. We were leaning towards the view that concerns over the current account deficit, fiscal slippage and rising inflation were beginning to be priced in, but the risks around politics have turned less favourable for markets after the by-election losses in Uttar Pradesh (after a positive BJP showing in state elections in February). Although the main state election risks will be towards year-end (although the next focus will be Karnataka in May), politics could remain a near-term focus given the risk to fiscal policy and economic reform.”