Author: David Chao (Global Market Strategist, Asia Pacific)
India’s 6-week long general election is finally coming to a close, with the official results being announced on the 23rd May. Recent exit polls point to a much stronger than initially expected win for Modi’s BJP party and NDA collation – allaying fears of a potential upset or that the coalition would fall short of a majority.
According to polls, the NDA is expected to win between 267-350 parliamentary seats – well above the 272 seats needed for control. Exit polls in India have had mixed results in accurately predicting the number of seats won – however if predictions are correct, investor optimism for a stable government with a stronger mandate - and policy continuity for another 5 years, should lead to a strengthened rupee and continued market outperformance for equities and fixed income.
Leading into the election results, investors withdrew USD 700mn from local shares and bonds due to election results uncertainty and the escalating US-China trade war. However, according to OECD research, India’s economy is relatively closed and insulated from global trade. India is the US’ 9th largest trading partner and has often been touted as a possible net beneficiary of the US-China trade war, as businesses look to diversify their supply and manufacturing chains in the IT, auto and textiles / apparel industries. Last month, Foxconn announced that it is starting trial production of the latest iPhone X outside Chennai, India.
India’s attractive structural growth drivers such as a large population and rapid urbanization rate have led to outpaced economic growth. A stronger win for Modi reassures investors that GDP growth should persist at a healthy clip over the next 5 years - as prior economic reforms in areas such as the goods and services tax, bankruptcy code will be seen through.
A strengthened Modi could lead to less populist government policies – such as cash transfers and loan waivers – and help grow tax collections through implementing more stringent corporate tax compliance. An enabling regulatory environment could lead to progress in implementing long-awaited reforms such as privatizations in the agriculture and financial services industries, equitable land auctions and an opening-up of new export markets.
Financial risks and economic concerns remain – in order for the markets to remain buoyant, Modi must present and implement compelling policies to tackle India’s twin current account and fiscal deficits. Recent growth and inflation indicators have also been weak. During his election campaign, Modi committed to boost investments into the Indian economy by cutting the cost of capital – investors can expect the Reserve Bank of India (RBI) to further ease monetary policy through a rate cut as early as June and a possible liquidity injection to recapitalize public sector banks.
Although India’s election results are important headlines to pay attention to as they impact near-term market prices, India’s economy is far more impacted by structural reforms and exogenous variables, such as the price of oil and external capital financing.
Current valuations for equity markets are already close to 20x forward earnings – somewhat capping any meaningful upside. However – a clear Modi mandate increases the chances that key economic and market reforms will be implemented – which builds the pathway for India’s longer-term economic growth and translates into revised positive corporate earnings momentum over the next 5 years.