Gujarat 2017, lessons for all

This election was the first since slow economic growth was apparent and in the data. A slow economy, however, was not the only factor — after all, in Himachal Pradesh, the BJP won by a large margin.

Affirming the robustness of our democracy, the Gujarat election result had good news for both the BJP and Congress. But given the symmetry in politics, one man’s ceiling is another woman’s floor. Hence, one does not have to weave complicated theories, or twisted arguments, to explain the outcome. And it wasn’t a simple result of wins and losses.

This election was the first since slow economic growth was apparent and in the data. A slow economy, however, was not the only factor — after all, in Himachal Pradesh (HP), the BJP won by a large margin. How important a factor the economy per se was is examined later. But first, let’s review what happened.

The BJP won 99 out of 182 seats, its lowest tally in the last six elections. There was, naturally, a strong anti-incumbency effect. Nevertheless, the incumbent’s vote share increased from 47.8 per cent in 2012 to 49.1 per cent in 2017. How did this happen, that is, vote share increases in a two-party fight and the number of seats falls from 115 to 99? Because the vote share of the main opposition party, the Congress, and its two small allies, increased by a larger 2.5 percentage points (ppt).

In addition, the turnout decreased by 2.9 ppt from the previous assembly election, and the share of NOTA votes registered at 1.8 per cent, among the highest recorded in state elections post the 2014 national election. The turnout decline is actually larger than 2.9 per cent because there has been a trend of increase in turnout in the assembly elections over the last few years.

Who stayed at home or voted NOTA? It is unlikely that a Congress voter stayed away. More likely, it was the BJP voter who could not get herself to vote for the BJP. Two-party elections are essentially about getting the middle of the electoral distribution. It is clear that the BJP was able to get the middle, and beyond, in the parallel Himachal Pradesh (HP) election. The 2017 BJP victory was the fifth highest in HP state elections for any individual party.

One result, noted by many, is the sharp rural-urban divide in the Gujarat election. Out of 58 rural seats, the BJP won 20 and the Congress won 37. In urban areas, the BJP won 45 seats and the Congress just eight. In the remaining 71 seats, the seat shares of the two parties were near even. From this, can it be concluded that INC+ obtained the surprise result of 80 seats because of “rural distress”? And that hence, when Rajasthan, Madhya Pradesh and Chhattisgarh go to the polls in November 2018, the BJP is in for a tough fight?

There are two points that analysts need to consider before drawing any conclusions about trends and forecasts. First, considerable amount of research is pointing to the fact that urbanisation in India is considerably higher (almost double) than the 2011 Census estimate of 31 per cent. This means that if the vote is based on rural/urban, then the Congress will likely not benefit to the extent that it might believe is indicated by the “rural” Gujarat result. Second, urbanisation in HP is less than a third of Gujarat’s (Census estimate) and the BJP did rather well in dominantly rural HP.

In several articles, we have alluded to the possibility that ultra-high real interest rates in India only help the lazy bankers, foreign investors and the political opposition. These high interest rates happened when the economy had already faced two major shocks — demonetisation (announced on November 8 2016) and GST (implemented from July 2017). High real rates were the third shock that slowed the economy. Recall that Rahul Gandhi had pointedly emphasised slowing GDP growth (and associated concerns) about job losses in his near-successful electoral campaign. It is difficult to isolate the effect of each of the above three factors on the Gujarat vote, but herewith an attempt.

The first is demonetisation. In March, the largest, and one of the poorest states, Uttar Pradesh (UP) voted for the BJP in record numbers (40 per cent vote, more than 75 per cent seats); this was the first BJP victory in the state in 20 years. The GVA growth (gross value added and the measure “targeted” by the RBI) had increased by only 5.6 per cent in 2017Q1, the slowest such growth since the 5.4 per cent recorded in 2012Q2.

Thus, one conclusion from the outsize UP election result: Demonetisation was a politically popular move. Further, if municipal elections are any guide to the “mood” of the voters, BJP’s respectable to exceptional performances in the urban local body elections held post demonetisation in Delhi, Maharashtra, Rajasthan, Gujarat, UP and Chandigarh suggest that demonetisation is a vote-getter for the BJP. So, this does not explain the close Gujarat fight.

The Goods and Services Tax (GST), a large scale economic reform, is going through expected “teething” troubles. The BJP won in both the states (HP and Gujarat), and it won by a large margin in the urban areas, that is, the constituency most likely to be negatively affected by GST problems voted overwhelmingly for the BJP. Thus, GST does not appear to have been a factor in the Gujarat election.

This leaves one with the third explanation — high interest rates leading to slow GDP growth leading to relative unpopularity of the BJP and the increased popularity of the Congress. How valid is this conclusion?

We examine this question via the prism of the economic performance in 2014Q2-2017Q1 (the early easy electoral victory period for the BJP) and the economy in 2017-18 (since April 2017).

The table documents the data for important growth indicators in the two periods. This comparison makes clear that it is difficult to argue that the slowdown in the economy was not a factor in the Gujarat election, the first election in a slow Modi economy.

Slow farm income growth was likely a contributory factor to the current “farm distress” in Gujarat. However, last year (2016-17) was a good agricultural year after two years of drought. Hence, low farm income growth (2 per cent recorded in fiscal year 2017-18) was to be expected on the back of good growth in 2016-17, after two successive drought years. This is not a judgement on whether the agricultural growth is right; it needs to be increased, for economic, equity and political reasons. But the fact remains that low agricultural growth in the two drought years did not dent Modi’s popularity — so why should it be an important factor in the Gujarat election?

Average growth in construction, a heavily labour-intensive activity, has also been lower than the average of the preceding Modi years. This sector has experienced a steep decline in growth — an average of only 2.3 per cent versus a preceding average of 3.8 per cent.

Buffeted both by high interest rates and high NPAs, industrial growth has halved from an annual average rate of 7.3 per cent to just 3.7 per cent per annum. Credit growth to MSMEs (the poor component of industry and one for whom cost of credit is very important) has collapsed from an earlier 4.5 per cent growth to just 0.6 per cent in the last eight months.

If slow growth is both an economic and political problem, what can the Modi government do? The two known levers of policy to influence demand are monetary and fiscal. Regarding the latter, it seems that fiscal policy has nearly run its course, and there is very little room left to manoeuvre. More than 90 per cent of the fiscal deficit target of 3.2 per cent for 2017-18 has been “exhausted”, and four months of the fiscal year remain.

In my personal view, the only policy lever for the short term (next 12 months) is monetary policy. The real repo rate averaged 2 per cent prior to fiscal year 2017-18, and 3.1 per cent this fiscal year. Very few countries accelerate growth with either this level of real interest rate (> 3 per cent) or this large increase in real rates (5 percentage points in the last three years). And India has been hit with both.