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India’s elections that concluded on 1 June did not deliver the expected landslide victory for Prime Minister Narendra Modi and his Bharatiya Janata Party (BJP). The BJP lost its majority in parliament, meaning Modi must work in a National Democratic Alliance (NDA) with two smaller parties whose leaders are known to switch sides often.

For Modi, an NDA government will not be as easy to run as a BJP government with control of the parliament. Consequently, the  to the election results, though this reaction has been toned down as the outlines of an NDA coalition have become clearer.

Modi has already been in power for ten years, time he has used to improve India’s balance sheets on two fronts: the current account and fiscal balances. First, on the external front, India is now much less prone to shocks, as its current account deficit has been reduced substantially. However, India’s greater resilience comes not from stronger exports but from weaker imports, notwithstanding the booming economy. This is mainly due to import substitution: domestic products are shielded from foreign competition by high tariffs and expanding industrial policy. This resembles much more Latin America in the 1970s than China after its entry into the World Trade Organisation, when import tariffs were slashed to facilitate the entry of foreign manufacturers and, with them, technological transfer and improved business practices.

Modi’s timid trade liberalisation is one of the main reasons why foreign direct investment into India, especially in manufacturing, has remained underwhelming. Under a coalition government, it seems hard to believe that trade liberalisation will speed up, and that local industrialists and trade unions will be less powerful than so far.

Meanwhile, developed economies, especially the US but also the EU, are looking to de-risk their links with China. India is an obvious alternative, given the size of its population and market potential. India’s geopolitical tailwinds are there to stay but investors will want to see more opening up before they jump into the Indian market, especially since many have already gone through a rather negative experience, in terms of market access, with China. 

Second, on the fiscal front, Modi has somewhat improved India’s position although the deficit remains large. The most important achievement was the introduction of a goods and services tax, in place since 2017. The larger fiscal revenues this triggered have mostly been used for public investment, especially in infrastructure. With a coalition government, however, Modi might have no choice but to increase welfare programmes, reducing the room for public investment. Given the amount of investment India needs to reduce its infrastructure gap, this is clearly a problem down the road.

Finally, the election results showed how important it is for a large and labour-intensive country like India to create manufacturing jobs. India has done very well in the information technology sectors, but this job creation is only for the most-skilled workers, leaving many others behind. To create the necessary jobs to double India’s , labour-intensive manufacturing will be needed. Governing in coalition will only increase the problems that Modi had already been facing in his first two mandates.

Given these factors, it seems safe to expect much slower economic reform in India and lower potential growth. Still, given the fact that India is the only country big enough to enable the reshuffling of supply chains away from China, the international attitude towards India is expected to still be positive, despite the less-clear reform path.

In conclusion, India’s election results do not bode well for economic reform, but they have shown the resilience of India’s democracy. For Europe, the former is not good news, but the latter clearly is. The European Union needs a strong Indian economy for its exports and as an alternative to China for its manufacturing FDI. This prospect is now more distant. But exactly because of this, India might be more willing to strike a trade deal with the EU at a time of major global uncertainty and great-power competition between the United States and China.

An EU-India trade and investment deal would be extremely important for both as it would offer EU companies access to a very large and growing market and would also offer India more manufacturing FDI from Europe. European Free Trade Association (EFTA) members and India have involving a $100 billion investment commitment from EFTA members. The EU could be next, especially as Modi’s new government is even more desperate to create jobs.