Winner in India Elections Will Face Battle to Restore Economic Growth

Winner in India Elections Will Face Battle to Restore Economic Growth

Investors Betting on Change Pushed Country’s Stocks to Record Highs

SHEFALI ANAND And DEBIPRASAD NAYAK

March 26, 2014 11:10 a.m. ET

MUMBAI—Investors betting on a change of government in India pushed the country’s stocks to record highs Wednesday. But whoever takes the reins after the elections that start next month faces an uphill battle to restore growth in Asia’s third largest economy.

The country’s benchmark S&P BSE Sensex has jumped more than 5% in the last month. It reached an all-time closing high of 22,095.30 points Wednesday, helped by hopes a new business-friendly government will soon be in power in New Delhi.

The rupee—which was among the worst-performing currencies in the world last summer—hit an eight-month high Wednesday of INR60.14 to the dollar.

Investors are wagering national elections, which go from early April until mid-May, will topple the ruling Congress-led government which has been slow at revamping the economy during its 10 years in power and instead focused on providing more subsidized food, jobs and other perks to the poor.

The current administration’s neglect of some important economic issues, including bureaucratic reform, infrastructure and corruption, is why India’s growth rate is stuck near a ten-year low of less than 5%, naysayers say.

While the stock market and the rupee have been rallying on the belief India’s main opposition party, the Bharatiya Janata Party, and its prime ministerial candidate Narendra Modi would be able to revive growth, investors may be getting ahead of themselves. Mr. Modi would have to deal with some of the same challenges that had hobbled the Congress party’s attempts to push reforms, some analysts and investors warn.

“The upside is a bit too overdone in our view,” said Miguel Chanco, India economist for Capital Economics, a London-based research company.

The BJP has yet to release its economic agenda, though Mr. Modi has said he would focus on creating jobs and reducing corruption. As chief minister of the western state of Gujarat, he built a reputation as a strong leader who helps businesses by building infrastructure and reducing red tape.

The answer from Congress has been more of the same. On Wednesday it released its election agenda, promising to expand health care, housing and other benefits for the poor and disadvantaged.

Despite the market rally on what some are calling “Modi magic,” analysts warn that even if the BJP does win the most seats in Parliament, it will still likely need to tie up with smaller regional parties to form the federal government. That means the Hindu nationalist party would face the same problem of getting coalition partners to pass unpopular reforms.

Mr. Modi’s own party is split on one of the most important economic reforms in recent years, the opening of India’s retail industry to more foreign participation. Some Indian states which are governed by the BJP have opposed the opening to companies like Wal-Mart WMT -0.83% Stores Inc.

Meanwhile, many of the regulations most in need of change are set by state governments, so just having a new face in New Delhi wouldn’t be enough.

For instance, India needs more investment in power generation, but states which control power distribution don’t want to boost what they charge for electricity and often refuse to pay higher prices to private power companies.

As most road building is also under the jurisdiction of state governments, construction of new roads will take time, no matter which government comes to power.

“You can’t wish away these problems in a jiffy,” said Vivek Mahajan, head of research at Mumbai-based brokerage Aditya Birla Money.

Investors point out that it isn’t just politics pulling the market higher. India’s economic fundamentals are starting to improve and that has convinced many investors, particularly foreign institutional investors, to return in recent months.

India’s inflation rates have come down to a manageable level and its chronic current-account deficit has shrunk significantly thanks to curbs on gold imports last year when India was mentioned as one of the “fragile five” emerging markets for its imbalances.

“Inflation has moderated for last three months now and the trend seems to be clearly downwards,” said Harsha Upadhyaya, Mumbai-based chief investment officer for equities at Kotak Mahindra Asset Management Co.

Lower inflation will give India’s central bank more room to cut interest rates, which in turn will help boost growth. The Reserve Bank of India is expected to hold its benchmark interest rate steady at 8% in the policy meeting on April 1, but many expect rate cuts before the end of 2014.

Meanwhile, India’s current-account deficit, which was a record $88 billion in the financial year ended March 31, 2013, has been cut nearly in half this year.