‘Still a strong story.’ Why India’s election shock won’t derail its economic boom

New Delhi (CNN) — Narendra Modi has declared victory in India’s election but he’ll need the support of smaller parties to govern, a shock result that could make it harder for him to pass major economic reforms.

India boomed during Modi’s first two terms as prime minister, leapfrogging the United Kingdom to become the world’s fifth biggest economy and growing by 8.2% in the last fiscal year.

But the new government will need to make more big changes to sustain that pace if India is to become an economic superpower and a manufacturing rival to China.

“With a more fragmented government, we believe policy making in general is going to become more difficult going forward,” said Peeyush Mittal, a portfolio manager at Matthews Asia, a San Francisco-based investment fund.

Experts have highlighted land reform as an example of policies that might now be tougher for Modi to implement. Companies face more barriers to accessing land in India than in China. It is also much harder to hire or fire workers.

India will need to address those issues if it is to capitalize on the massive rethink underway among companies on supply chains. International firms want to diversify their operations away from China, where they are threatened by rising tension between Beijing and Washington.

Some of the world’s biggest firms, including Apple (AAPL) supplier Foxconn, are expanding their operations significantly in India. But while the country has emerged as a major hub for electronics manufacturing, it is still lagging behind China in sectors such as clothing, toys and furniture.

Despite the surprise electoral setback for Modi’s right-wing, Hindu-nationalist Bharatiya Janata Party (BJP), experts say the world’s fastest growing major economy will continue to live up to its billing.

“The Modi administration still has enough of a mandate to enact reforms that will keep potential growth at 6% to 7%,” Shilan Shah, an economist at Capital Economics, said in a note on Tuesday. “That would leave the economy on course to more than double in size over the next decade.”

A shock result

The BJP fell short of securing the 272 seats needed to win an outright majority in parliament, a stunning upset that leaves them reliant on coalition partners.

The party’s underperformance led to a plunge on India’s stock market, which had its worst day in four years Tuesday. Investors had been hoping for a strong, business-friendly government and had sent stocks to record highs Monday after weekend exit polls suggested Modi was on track for a bigger win.

But analysts say that the next government will still be strong enough to ensure India becomes a global growth engine and remain an attractive destination for investors and companies. On Wednesday, stocks were up 3%

The Indian economy is poised to become the world’s third largest behind only the United States and China before the end of this decade.

“The lack of absolute majority doesn’t derail this broad economic agenda envisaged by the BJP,” said Aditya Suresh, head of India equity research at Macquarie Capital.

In the long-term, he sees the government focusing on job creation, manufacturing and “improving ease of doing business.”

India’s so-called “demographic dividend,” the potential economic growth arising from a large working-age population, represents a major opportunity. Its vast consumer market and pool of affordable labor should continue to draw more attention from global brands and trading partners.

Fundamentals still strong

Asia’s third biggest economy will also benefit from friend-shoring, a trade practice where supply chains are moved through allies, said Shah. While tensions between Beijing and the US are rising, New Delhi enjoys warm relations with Western nations.

Modi’s government has overseen a construction boom, spending billions building roads, railways and airports. Apart from that physical infrastructure, India has also built a range of public digital platforms, including the Unified Payments Interface (UPI), that have transformed lives and businesses and should continue to aid with economic expansion.

India is “still a strong story benefitting from democratic elections, a market-friendly government, attractive demographics, momentum out of China, and a unique digital stack, said Malcolm Dorson, head of emerging markets strategy at global investment management firm X.

“Investing in India is about much more than this election. It’s a 20-year story, and not one the depends on the next two weeks,” he added.

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