Indian Prime Minister Narendra Modi suffered one of his biggest setbacks since taking office with a defeat in a crucial state election, dealing a blow to his push for economic reforms. 

His opponents led by incumbent Bihar Chief Minister Nitish Kumar won 73 percent of seats in the state’s 243-member assembly, with the Modi-led National Democratic Alliance taking 24 percent.

Modi said on Twitter that he called Kumar and congratulated him on his victory.

The outcome will embolden opponents who have sought to block key economic reforms like a national sales tax while portraying Modi’s government as intolerant of religious minorities. That’s bad news for India’s stocks and currency, which are expected by some analysts to fall when markets open on Monday. One-month rupee forwards slid 0.7 percent, headed for the biggest drop since Aug. 24.

It also hurts Modi’s longer term goal of taking power in the opposition-controlled upper house of parliament, where members are chosen by state legislatures. His Bharatiya Janata Party-led alliance needs to perform well in about 10 state elections through 2017 to have a shot at controlling the upper house and ending gridlock that has stifled reforms.

“The NDA defeat in Bihar represents a striking repudiation of the ruling alliance," said Milan Vaishnav, associate in the South Asia Program at the Carnegie Endowment for International Peace. “The Modi magic worked well in recent state elections where anti-incumbency sentiment was sky-high. This was not the case in Bihar, where Nitish Kumar had a governance track record most voters rated positively."

Under Kumar, Bihar’s economic expansion has averaged more than 10 percent a year, exceeding the national rate. Kumar’s supporters credit his Janata Dal (United) party with restoring law and order to Bihar and providing residents with roads, electricity and food.

David Fuller's view

This is the first significant setback for Narendra Modi since his landslide election victory in May 2014.  However, it probably says more about Behar’s Chief Minister Nitish Kumar than Modi.  Bihar is a poor state, perhaps too often ignored in the past by India’s national governments. 

Fortunately, Bihar has finally benefitted under Kumar’s leadership, as the growth rate of more than 10 percent a year testifies.  Why would any resident of Bihar take the risk of removing a leader who has clearly helped his state, as we can see in the last paragraph of Bloomberg’s article reproduced above?

Modi would have a lot more to worry about if Bihar was badly governed and spiralling further into poverty.  However, this election defeat has shaken the Prime Minister’s aura and some investors have pulled out.

Personally, I will stay long and possibly increase my investment in JPMorgan’s Indian Investment Trust if we see a bigger overreaction.  Currently, it trades at an attractive discount to NAV of -12.60%, according to Bloomberg.  When JII is next accelerating above a rising 200-day MA, I plan to lighten this long-term position slightly as that would probably be a sensible policy.