Reforms and Accelerating Growth are the Key to Political Power in India

The Indian general elections – the “world’s largest exercise in democracy” – will take place a little less than a year from today with an electorate larger than that of all 34 OECD countries combined electing their parliamentary representatives. In the previous 2014 election, the BJP's coalition, led by Prime Minister Narendra Modi, secured a large parliamentary majority on the back of significant voter disillusionment with the previous Congress-led coalition government which was plagued by several high-profile corruption scandals, which resulted in a sharp slowdown in both reforms and growth. Against this backdrop, voters backed Mr. Modi’s promises of reform and his track record of delivering rapid growth in his home state. Mr. Modi’s government inherited an economy which had slowed to c.6% and was out of favour with international investors and leveraged his party’s parliamentary strength to implement a series of reforms which helped revive growth to c.8%. However, two major back-to-back reforms – demonetisation and the implementation of a national goods and services tax – adversely impacted growth from late-2016 until mid-2017 and have contributed to anti-incumbency against the BJP which has suffered setbacks in some recent regional elections, in spite of growth recovering back to 7-8% levels over the last year. A previously fractured opposition of a weakened Congress and several regional parties has united (at least temporarily) to take on the BJP and appears to be gaining in recent opinion polls for upcoming state elections and hoping to post a credible challenge to the BJP’s majority in the general election next year. Economic growth and reforms again promise to be the key issues of the upcoming election, and the assessment of Mr. Modi’s economic performance is at the epi-centre of the narrative for both the BJP and the opposition. This month’s Sign analyses the current government’s economic performance relative to its predecessors to better understand what drives electoral success in India, seeing not only an obvious improvement vs. the last government but also the potential for a structural step-up in the country’s future growth, a conclusion, perhaps, currently being largely overlooked by India’s electorate.


Economic Performance – Who has Delivered?

As India’s Prime Minister, Mr. Modi has overseen a turnaround in economic growth from c.5-6% to c.8% and scored substantial reform victories, seeing his party rapidly expand its national footprint and win multiple state legislatures as a result. More recently, however, the economic shocks from the implementation of two key policy reforms – demonetisation and the Goods and Services Tax (GST) – widely, particularly internationally, perceived to be bellwether reforms evidencing that the Modi government was serious about change – resulted in almost six quarters of decelerating growth and opened up a front for the opposition parties to challenge the NDA’s political capital, and enabled them to collectively defeat the BJP in some regional elections. More worryingly for Mr. Modi, while his personal popularity remains high, opinion polls for upcoming state assembly elections and the general election have been showing an erosion in support for BJP-led NDA alliance, whose parliamentary majority of 62% secured in the 2014 general election has eroded to 58% currently (due to interim regional and ‘bypoll’ elections), and according to recent opinion polls, the upcoming general election could see that fall further to 52%. To put that into context, this would see the Congress-led UPA double its strength from 11% of parliament currently to 22% . If the trendlines continue in this direction with any further erosion in the NDA’s vote share, the UPA could potentially form alliances with other regional parties and challenge the NDA’s ability to form the type of government it wishes, at the least.

The opposition and its supporters, led by Congress, argue that Mr. Modi has disappointed on his election promise of ‘achche din’ (translated as “good days”), has overseen inconsistent and insufficient growth, and has proven to be ineffective at implementing the most critical reforms. The BJP’s response is that Mr. Modi had inherited a sclerotic Indian economy in need of restructuring which had fallen out of favour globally, and was sputtering under a corrupt Congress coalition, driven by years of profligate lending and inflationary growth. Under the Modi government, FDI has not only revived but reached an all-time high, while inflation and the fiscal deficit have been contained, the stock market has boomed, and the country has regained favour with the international community. Moreover, with the economy stabilised, GDP should now continue to accelerate, driven by the broad reform program Mr. Modi has implemented. They also counter that a fossilised Congress Party, still beholden to the Gandhi dynasty, and its disjointed coalition of regional interests will only be a harbinger of political instability and policy paralysis and cannot possibly engineer the reforms required to unleash the Indian economy.

So, who is right? In addition to the over 800m voters, another c.80m people are projected to enter the workforce during the next government’s term, and so who can best manage and unleash the Indian economy will be a critical factor in the upcoming election. Voters’ collective answer to this question may well determine its winner. To form a perspective on this, voters will need to assess Mr. Modi’s economic performance, and although they are most likely to do that on an absolute basis and relative to the failure of the UPA government in its final years, it is worth looking at the performance relative to his predecessors over a longer period (including from older, better-performing Congress-led governments). This longer-term view is of relevance to Mr. Modi’s government as well as the opposition as it provides important insights about the economic factors which have driven electoral success, and therefore the key lessons for both parties as they seek to persuade voters at the polls next year.


Context: India’s Political and Economic Evolution Since Reforms (1991)

Prior to 1991, India had been governed for most of its history by the Congress Party , led by the Nehru-Gandhi dynasty, which enjoyed absolute majorities in parliament, including the largest majority ever in 1984 where Rajiv Gandhi won over 400 out of 539 parliamentary seats. Plagued by corruption scandals, Mr. Gandhi lost his majority in 1989 to a series of short-lived “United Front” governments of regional parties, which marked the beginning of the coalition era of Indian politics, roughly coinciding with the transformative liberalisation reforms which ended the elaborate system of business regulations and red tape known at the ‘License Raj’, which had kept GDP growth below 4% for decades.

Since then, power has shifted back and forth between BJP and Congress led alliances while the country as a whole has seen rapid economic development, with GDP growing c.10x from US$250bn to US$2.5tn today. While these governments oversaw the country under shifting geopolitical and strategic circumstances, they were ultimately working with the same macroeconomic drivers that remain the source of India’s growth potential today - its young population, low cost structure, strong services sector, entrepreneurial talent, and natural resources. The inset below shows India’s overall growth under the successive governments formed since 1991 with a brief description of each.

Five Core Areas of the Economy Reveal Who Performed and Who Did Not

While there are a multitude of internal and external factors that drive economic performance, and many factors are not arguably fully in the control of government, evaluating metrics across the following five categories provides a fairly strong assessment of the economic performance of each of these governments:

  1. Macroeconomic Growth: In addition to overall real GDP growth, which measures the fundamental increase in economic activity, it is important to look at the quality and volatility of growth as well as the level of over/under-performance over global growth and benchmark economies to better identify the government’s contribution to the growth achieved
  2. Savings, Investment and Credit: Savings, investment and credit are the building blocks of high quality and sustainable growth, influenced by a variety of structural factors, including fiscal and monetary policy, best measurable by indicators such as financial savings rates, domestic and foreign investment levels and credit levels
  3. Reforms and Governance:Good governance and well executed reforms are key in encouraging investment and growth. While the success of a given set of reforms can usually be measured directly, overall governance quality is more challenging to capture, with changes in international governance rankings providing an indication of performance changes between governments
  4. Macroeconomic Risk: It is important to assess government performance not only in driving growth, but how adeptly they are able to manage key destabilising risks such as inflation, internal (fiscal) and external (current account) balances, and its currency. Successful governments are not just those which foster rapid growth, but those that can sustain this through lower risk
  5. Stock Market Performance: The impact of macroeconomic policies invariably flows through to impact equity market returns, both in terms of earnings growth, and the relative valuations assets achieve given risk premiums and other factors. It is instructive to deconstruct equity market performance into earnings growth, change in valuation multiples and performance relative to global benchmarks in order to form a comprehensive assessment of the government’s performance

By evaluating the performance of each government on a series of indicators and metrics for each of these key areas, a more objective view of their overall economic performance can emerge, helping voters form a more balanced view on who can best deliver economic development and helping India’s leaders understand the key economic factors that drive electoral success.


Macroeconomic Growth

India’s Overall GDP Growth Since 1991. India’s economy has progressively accelerated since 1991 with reforms under successive governments to c.7-8% GDP growth p.a. However, the quality and volatility of growth under each government has varied significantly:

  • Initial Coalitions. India’s economy accelerated rapidly initially to over 6% growth but stumbled in the final years as reforms stalled under the two short-lived United Front governments.
  • NDA I. Rapid reforms drove growth to 8%, only for it to halve in the aftermath of the dot-com collapse from FY01 to FY03 and recover back to c.8% in its final year.
  • UPA I. The Congress-led UPA inherited an economy growing at 8% and undertook further reforms, which with tailwinds from the global liquidity-driven emerging markets boom, helped growth accelerate to c.10% from FY06-FY08 before declining to 4% in FY09, these were the years of the global financial crisis, which initially India seemed to weather.
  • UPA II. After an initial stimulus-driven recovery, the UPA failed to sustain growth as reforms and administrative decision-making stalled with the government facing several high-profile corruption scandals. Growth fell by 50% from c.11% in FY11 to 5.5% in FY13, paving the way for Mr. Modi’s political rise in 2013-2014.
  • NDA II. The Modi-led NDA government leveraged its parliamentary majority to rapidly implement reforms across several areas which helped the economy accelerate to over 9%; however economic shocks from two major reforms in November 2016 (demonetisation) and June 2017 (GST implementation) led to a fall in growth to c.6%. In the last year, as the impact of these structural reforms has tapered, growth has accelerated from 6% back to 8%.

Important points regarding the quality of growth:

  • India Vs. Global Growth. While India was able to achieve rapid growth rates of 10%+ prior to the financial crisis during UPA I, this was primarily a function of an acceleration of emerging markets globally to over 7%. Its recent acceleration to c.8% growth under Modi however has been at a time when both world and emerging market growth is considerably slower, thus indicating a greater level of ‘outperformance’ vs the rest of the world and making India an increasingly important driver of global growth itself.
  • Volatility of Growth. Analysing the volatility of GDP growth reveals that overall volatility in the years leading up to the current government has been consistently high, with the significant decline under Mr. Modi pointing to the execution of a more sustainable and consistent growth story.

Savings and Investment, Credit Growth, and Foreign Direct Investment

Savings and Investment. The acceleration in India’s growth potential in the years following liberalisation was driven by a steady increase in financial savings and capital formation. While having declined from their peaks pre-global financial crisis, financial savings recovered to 21-22% under the Modi government, driven in large part by the long-term rise in private sector profits c.4% of GDP under the initial coalitions to 12% today. While a slowdown in asset intensive construction has driven a decline in investment from a peak of 34% in FY12 to 29% under Mr. Modi’s tenure, this has been partially offset by an increase in intellectual property investments, whose share of GDP has increased from 2.6% to 3.6% in the last 5-6 years.

Foreign Direct Investment (FDI). FDI became an important driving force of economic growth from the mid-2000s and has increased from less than 1% of GDP to currently over 2.5%. After rising to US$47bn in FY12, FDI declined in the final years of the UPA II’s term due to the policy stasis and an international crisis of confidence in India, as institutional investors pulled out capital. Mr. Modi’s reforms and aggressive courting of international capital helped reverse this trend, and total FDI has crossed US$60bn each year in the past two years, and averaged c.2.5% of GDP.

Governance, Inclusion and Reforms

Governance: Major Improvements in Economic Freedom, Business Environment and Government Integrity. Following a period of stagnation under the UPA II, India under Mr. Modi has seen major improvements in economic freedoms and efficiencies driven by the BJP’s comprehensive program of reforms. Further, India’s rankings in the global ease of doing business and competitiveness reports have increased sharply as Mr. Modi’s government has focused on a range of administrative reforms which have reduced the regulatory burden for businesses and streamlined government approvals. Additionally, perceptions of government integrity have improved markedly, after an international loss of credibility from high-profile corruption scandals under the UPA II government.

Important points regarding the Operational Environment:

  • Reforms: Pace and Intensity Critical: The pace and nature of reforms have varied significantly under various governments since liberalisation. The analysis shows that Indian voters reward governments which undertake rapid and comprehensive reform (such as the success of the UPA government in securing a second term) and punish those that fall into policy paralysis by voting them out (as they did with the initial United Front coalitions and the UPA II). Mr. Modi’s government reform track record in this regard is relatively strong given both the breadth and depth of reform initiatives executed by the government in terms of the number of sectors they have been impacted (financial services, infrastructure, manufacturing, information technology, resources, etc.) as well as the deep reforms to areas like taxation (through the GST) and financial services (through the new insolvency and bankruptcy legislation).
  • Inclusion: Big Boost to Financial Inclusion Under Modi. India’s ‘inclusion metrics’ in terms access to education, banking, electricity and connectivity have continued to expand since reforms were launched, with India achieving near universal primary education, and significantly increased enrolment ratios in secondary and tertiary education. Mobile connectivity and access to electricity also expanded rapidly under UPA II and continued under the Modi government as investments in telecommunications and power infrastructure helped expand access. There has been a significant boost to financial inclusion under the current government, with Mr. Modi’s Jan Dhan Yojana initiative helping increase bank account penetration to 80%.

Macroeconomic and Currency Risk

Key Macroeconomic Risks. India’s key macroeconomic risk metrics – the fiscal deficit, current account balance and inflation – deteriorated sharply under the UPA government and have improved under the Modi government, in particular:

  • Fiscal Deficit Lowered to 3.5% of GDP. In the years following the global financial crisis, the UPA government launched a large fiscal stimulus which helped India’s economy rebound rapidly in FY10 and FY11, however the central government’s fiscal position deteriorated sharply to 6.5% of GDP in FY10. After improving to 4.5% in the final years of the UPA II, Mr. Modi has further consolidated government spending on the back of strong tax collections.
  • Improvement in Current Account Position. India’s current account balance deteriorated significantly under the UPA from a c.2% of GDP surplus when it came to power to a peak deficit of c.5% of GDP in FY13 due to India’s continued dependence imports of oil (combined with rising oil prices) and gold. This was contained to a low of under 1% of GDP under the current government, to worsen marginally in the last year with rising oil prices.
  • Inflation Contained from 10% to Under 4%. Inflation averaged 6.7% and 8.1% annually under the UPA I and UPA II, respectively, due to expansionary fiscal policy and various rural welfare schemes. Fiscal and monetary policy under the Modi government has helped contain inflation to under 4%, allowing lower interest rates.

Currency Risk. The Indian rupee has consistently weakened over successive governments – irrespective of inflation levels, economic growth or other factors that typically drive currency exchange levels – with the only difference being its relative pace of depreciation. While a depreciating rupee helps exporters be more competitive overseas, depreciation adversely impacts global investors’ returns and furthermore can cause economic instability by driving inflation. The initial years following reforms were the most unstable with the rupee depreciating an average of 9% p.a. under the initial Congress and United Front coalitions. Exchange rate stability improved significantly under the NDA I government as India built up significant foreign currency reserves and was maintained in UPA I (which coincided with a period when emerging markets currency globally performed well). Under the UPA II however, the rupee depreciated sharply, by an average of 4% annually, driven by a widening current account deficit and foreign exchange reserves declining back to c.6 months of imports. While the Modi government has stabilised both the current account deficit and India’s external reserves, the rupee has continued to depreciate by c.3.5% annually in recent years.

Stock Market Performance

Equity Markets Performance. India’s equity markets have increased by c.30x since reforms started in 1991, delivering a 13% average annualised return over this period, with year-to-year returns driven by a combination of domestic factors and the global market environments.

    • Corporate Earnings Growth. The principle driver of equity returns over the long term has been corporate earnings growth which has averaged 8% after the global financial crisis (Jan-2010 until date). Under the Modi government, earnings growth has in headline terms underperformed with an uneven pattern overall, contracting in its second year (FY16). Part of this is due to addressing the large NPA provisions taken by the banks and the slowdown in India’s IT services sector. It remained stagnant in FY17 and FY18 due to the economic impact of demonetisation and GST implementation; however, earnings growth has recently recovered to reach c.16% y-o-y growth in recent months.
    • Change in Valuation Multiples. Increasing valuation multiples have emerged as an important driver of returns in recent years – the Sensex has returned 11% p.a. under the Modi government even though earnings growth during this period has been only 4% – reflecting a market ‘re-rating’ to reflect the lower risk profile under the Modi government and in anticipation of a rebound in earnings growth.

    • Total Shareholder Return (TSR) – India’s Alpha Rises Under Modi. Despite significant volatility, Indian markets have consistently delivered double digit returns over the last decade when considered over a medium-long term holding period (3-5 years). While global markets have been an important driver, India’s ‘alpha’ declined significantly in the UPA II government with the Indian markets delivering similar returns to the MSCI world index and worse performance than the US market. This has recovered under the Modi government with the large cap (Sensex) and midcap indices outperforming the MSCI World index by c.2x and c.3x, respectively.

Conclusion: The Modi Government’s Scorecard and Implications

The performance on each of the metrics in the five categories above is summarised in the table below and provides a picture of the Modi government’s economic performance relative to its predecessors. The tables are presumptuous in assigning school style grades, with the aim of making it easy to absorb the information.

The analysis provides for some important insights into where India stands today as the election process kicks off and what it takes to win:

India’s Voters Have Been Punishing Governments that Do Not Deliver Reforms. What stands out from the analysis and the scores, beyond the strong performance of the current NDA government, is the consistency with which Indian voters have punished governments that fell into policy paralysis and/or failed to deliver growth. In the last 20 years, only the UPA has managed to win a national election as an incumbent, with the UPA I government riding on a bubble of global credit expansion and emerging market growth, supporting large scale reforms and welfare schemes. However, its strong economic performance proved to be driven largely by external factors and therefore unsustainable and more importantly gave rise to a familiar pattern of corruption scandals and policy paralysis under UPA II, leading to growth collapsing from 10% to 6% and Congress’ massive repudiation in the 2014 election.

The Modi Government’s Bet on Reforms Coupled with the Previous Government’s Underperformance is a Strong Platform. By that measure, the BJP government, which has undertaken arguably the most significant and comprehensive reforms and overseen a sustainable recovery in growth to c.7.5% should be in a much stronger position that it currently finds itself in with regards to its electoral prospects, with the recency of the pain inflicted by the two major reforms and the resulting shock to growth providing what should promise to be only a short-term boost to the political opposition. The evidence suggests that Mr. Modi should seek to avoid the trap that previous governments fell into at this stage, overreacting and retreating from real reforms with long term benefits in favour of unsustainable populist policies and economic schemes to win back favour in the short-term. The actions of the Modi government to date provide the foundation for a step change in India’s growth, one that is required for the country to fully realise its demographic dividend, and any short-term populist measures the government could enact are more likely to hurt rather than help the country’s long-term growth prospects. It seems sound for the government to instead double-down on reforms and move forward on a more ambitious agenda focused on privatisation, employment generation, education, healthcare and other critical areas, to further clear the path for further growth acceleration

Congress Will Need A Compelling Economic Policy and Reform is Key. For the Congress and other opposition parties, the lesson to draw from the data is that it is not going to be enough to define themselves in opposition for Mr. Modi. Trying to fall back on the achievements of UPA I to relativise the performance accomplishments of the current government will not work when the memory of its abysmal performance of the UPA II government in its hand the messes Mr. Modi has spent the past five years cleaning up is still fresh in voters’ minds. It also seems highly unlikely that Congress will have the benefit of a global liquidity-driven emerging markets boom to provide tailwinds and fund similar populist welfare schemes to the ones which helped it return to power in 2009. Instead, Congress needs to offer a compelling vision for how it would govern and deliver reforms and growth in the current economic context and demonstrate that it has learned the right lessons from its years in (and out of) power. A compelling reforms agenda which defines the opposition not just as a bulwark to Mr. Modi, but rather as a positive force for India’s continued development would help it galvanise voters who are justifiably concerned about whether a disparate coalition of the Congress and regional parties can deliver a meaningful economic agenda, or even form a stable government in the first place.

The Weaknesses in Implementation of Reform Provide a Potential Weak-point for the Opposition. Mr. Modi’s reform program has provided a high benchmark for both the BJP and the Congress to surpass. The government has used its political strength to oversee a comprehensive reform program including both major reforms like the GST and a host of smaller reforms which have improved the business environment and catalysed specific sectors, and its success is evident in the sharp improvement on global indices measuring economic freedom and ease-of-doing business, amongst others. While the government has been accused of poor execution on some of its reforms and may well pay a price for this at the polls next year given the contraction in growth these have caused, the scope and scale of the reforms that it had completed clearly exceed those of the its predecessor.

Strong Leadership can Also Steer an Effective Coalition as India’s Recent History Shows. Investors may be concerned about the implications of the BJP potentially losing its majority or a loosely-knit Congress-led coalition coming to power, and the impact that a return to coalition politics could have on political stability and the ability of the next government to push through continued reforms. However, an important lesson from the analysis above is that a parliamentary majority is not necessarily a prerequisite for delivering on reforms. This is evident in the initial Congress-led government from 1991-1996 which launched the liberalisation program and the UPA I which initially implemented several significant reforms (despite both governments not having a parliamentary majority and being dependent on outside support). In both circumstances strong leadership within a coalition, and internal alignment around pursuing a reforms program, were critical. Without this, governments made up of disparate regional interests risk falling prey to corruption, infighting and ultimately policy paralysis. The United Front governments of 1996-1998 and the Congress own performance during UPA II provide ample evidence of this.

Mr. Modi’s government has overseen a strong recovery from the performance if its predecessor and its reforms have created the foundation for a structural step up in the country’s performance in the coming five years. Voters and investors will therefore need to look closely at the economic agendas of both the government and the opposition in order to choose the party who they believe can better pick-up where Mr. Modi’s first administration will be leaving off.

Moreover, during the next five years, India will likely encounter unprecedented levels of change, driven by a range of national and international political, economic, social, security, and environmental factors. The decisions made by India’s leaders during this time will likely not only shape the trajectory of its longer-term development but also establish what position India will play in the changing world order, potentially for decades to come. The winner of India’s 2019 general election will therefore not need only a compelling vision of India’s development and the opportunities this creates for its citizens but also a compelling vision of India’s place in the world, and one that is commensurate with its potential.


1.    Source: Time Magazine, May 2014

2.    India Today Mood of the Nation poll, August 2018

3.    The only exceptions to Congress rule came in 1977-1980 when Indira Gandhi’s government was ousted by a coalition under the leadership of Morarji Desai, only to be voted back three years later

4.    For the purposes of this analysis, the preceding Congress-led government and these governments (which were propped up through outside from the Congress) have been grouped and referred to as the “Initial Coalitions” of the post-reform period

5.    Data Sources: Reserve Bank of India, Ministry of Statistics and Program Implementation, IMF World Economic Outlook, GPC Analysis

6.    Data Sources: Reserve Bank of India, Ministry of Statistics and Program Implementation (MOSPI) National Accounts Data, Department of Industrial Policy and Promotion (DIPP) FDI Statistics, August 2018, GPC Analysis

7.    Data Sources: Heritage Foundation, WSJ Index of Economic Freedom, Transparency International, World Bank Ease of Doing Business Report, World Bank Development Indicators database

8.    Data Sources: Indian Ministry of Finance, Government of India; Reserve Bank of India; Ministry of Statistics and Program Implementation

9.    Data Sources: Reserve Bank of India Database on the Indian Economy, CapitalIQ

10.    Data used is for the Bombay Stock Exchange (BSE) index of 30 largest stocks (Sensex) because comparable data for broader indices of the market (including mid-caps) is not available for the period

11.    See appendix for definitions and sources