India: Volatility Amid Uncertainty

Coalition government is not necessarily a bad thing for investors

Date: 5 June, 2024

India’s general election, which is the largest democratic exercise in the world, requiring several months to complete, came to an end on June 1st. Exit polls had initially projected that Prime Minister Narendra Modi’s Bharatiya Janata Party (BJP) would win by a landslide. However, the final count could not be more different, leading to some disappointments.

Modi is set to return for a third term. However, the BJP suffered a major setback, winning 240 Lok Sabha seats across the country, and falling short of a majority on its own (272 seats). That leaves BJP dependent on alliance partners to form government (most likely the Telugu Desam Party and Janata Dal United). Over the past two elections, the BJP, and its allies under the ruling National Democratic Alliance (NDA) coalition, secured an increasingly larger share of seats (Chart 1). This election marks a sharp reversal of that trend.

The NDA has been able to implement important reforms over the past years, thanks in part to a strong mandate, a development which has been positive for markets. These include the “Make in India” strategy, which encourages companies to set up factories in the country (target of 12-14% growth per annum) and incentivises FDI into manufacturing. Besides, Modi has also published plans for India to become a “developed nation” by 2047, which will require investment into infrastructure and growth of around 8.0% per annum. The NDA also passed hard reforms such as the demonetisation drive and the 2016 bankruptcy code, safeguarding investor rights.

Through higher investment into infrastructure and human capital, India can unlock its potential growth. However, since BJP has not been able to secure a majority, that could leave Modi with a weaker mandate to forge ahead with difficult reforms. Although the country is poised to remain the fastest economy in Asia, a divided Parliament could entail slightly lower potential growth. Moreover, it is possible that the new coalition government could prioritize welfare spending over the fiscal consolidation plan, eroding the country’s fundamentals.

The surprise doesn’t have to be entirely bad news for investors. Although India is a multiparty democracy, under BJP majority rule, India has experienced a rise in discriminatory policies toward both foreign investors and religious minorities. The outcome of the 2024 general election partially reflects the intense ideological debate that is taking place within the country, with more voters supporting the secular opposition alliance. Modi’s Hindu Nationalist agenda will likely take a less prominent role in the absence of an absolute majority.

Initial exuberance, following the announcement of the preliminary results from exit polls, paved the way to a sharp correction on Tuesday and Wednesday. The market will remain volatile until the new alliance is formalised. Only then will we have a better idea of what the new budget and policy agenda will look like. Going forward, investors should monitor macro stability, specifically whether the new administration will adhere to the fiscal consolidation plan, or not.

A pullback in Indian equities is not a bad thing. The MSCI India index remains expensive, trading at 24.5x on a forward P/E basis, which is almost one standard deviation above its 10-year average (Chart 2). Given the structure of Indian markets, we observe a strong correlation between GDP growth and EPS growth over long periods of time. The election outcome doesn’t fundamentally shift this relationship.

This article is based on a previous report by UBP.