As the NDA is all set to form the government, Fitch Ratings on Thursday said coalition politics and a weakened mandate could make it challenging to pass legislation on ambitious reforms.
"We believe major reforms to land and labour laws will remain on the new government's agenda as it seeks to enhance India's manufacturing sector, but these have long been contentious and the NDA's weaker mandate will complicate their passage further. This could reduce the potential upside to India's medium-term growth prospects," Fitch said in a statement.
The BJP fell short of a single-party majority in the 543-seat lower house of parliament for the first time since its latest period in government that began in 2014.
But Fitch expects it to secure enough support from allied parties in the National Democratic Alliance (NDA) to form a government with Narendra Modi remaining Prime Minister.
The outcome should support broad policy continuity, with the government continuing to prioritise infrastructure capex, improvements to the business environment, and gradual fiscal consolidation, Fitch Ratings said.
"However, coalition politics and a weakened mandate could make it challenging to pass legislation on the more ambitious parts of the government reform agenda," it said in a detailed note post the Lok Sabha election results which were announced late on Tuesday.
The NDA appears set to retain power with a narrower majority after India's recent election, following a weaker performance by its dominant member, the Bharatiya Janata Party (BJP).
"We do not think that the government's losses at the ballot box will lead to substantial policy adjustments, but the post-election budget in July should provide greater clarity on its economic reform priorities and fiscal plans over the coming five years," Fitch said.
It said implementation of economic reforms during the first two NDA terms was mixed, but some positive measures were passed including the Goods and Services Tax (GST) law and Bankruptcy Code in 2016.
The government also increased public infrastructure investment significantly, helping to put India among the fastest-growing major economies in recent years, with real GDP growth reaching 8.2 per cent in the fiscal year ending March 2024 (FY24).
Fitch expects growth to remain rapid at 7 per cent in current fiscal (April-March).
"We expect India's medium-term growth performance to remain around our trend estimate of 6.2 per cent through FY28, despite the government's slimmer majority. The continued public capex drive to address infrastructure gaps, ongoing digitalisation efforts, and improved bank and corporate balance sheets - relative to the pre-pandemic situation - should facilitate a strong outlook for private investment," Fitch said.
The rating agency expects the Production-Linked Incentives (PLI) scheme to remain intact, which will help attract FDI in target sectors, such as electronics.
However, private investment has not yet accelerated meaningfully, which represents a risk for the outlook.
Fitch believe land and labours laws reforms will continue to advance at the state level in some parts of the country. There is also some potential for judicial reforms that would look to lower costs and speed resolution of court cases.
Weaker fiscal metrics relative to peers are a significant constraint for India's sovereign rating, which we affirmed at 'BBB-' with a Stable Outlook in January 2024.
"The next government's ability to address high fiscal deficits and reduce debt will be important considerations for the rating in the next few years.
"Sustained deficit reduction, particularly if underpinned by durable revenue-raising reforms, would be positive for India's sovereign rating fundamentals over the medium term," Fitch added.
The government has improved its record on achieving deficit targets and has advanced fiscal consolidation gradually over the past few years. We expect this focus on gradual consolidation to broadly be sustained.
The FY24 budget deficit came in at 5.6 per cent of GDP, below the revised budget estimate of 5.8 per cent (which matched Fitch's estimate).
Fitch expects the 5.1 per cent deficit target for FY25 to be attained, and said government's goal of reducing the deficit to 4.5 per cent of GDP in FY26 appears increasingly achievable, although the election marginally increased risks of higher spending or slippage in capex to accommodate greater social spending.
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