31 January 2019
India TV’s most recent nation-wide poll indicated the BJP and its broader National Democratic Alliance (NDA) would come out on top in the general election. However, after losing some significant state elections in December, and with new alliances emerging in states like Uttar Pradesh, we believe the NDA could lose its parliamentary majority, obliging it to assemble more coalition partners to form a government.
In the event of a hung parliament with no obvious strong coalition government, markets would come under considerable short-term pressure. This could prompt the central bank to intervene, particularly in currency and bond markets, and cut rates. In any other electoral outcome, there might be a period of volatility, but markets should remain relatively orderly overall.
India's fundamentals remain solid
Regardless, India’s medium-to-long term fundamentals would remain undiminished; the country’s structural consumption story, with an average nominal growth rate of 11-12 per cent, is tough to beat. Our view is that the weak private capex cycle has reached an inflection point and new non-performing loan (NPL) formation has peaked. As long as policies remained supportive of growth, financial markets shouldn’t stay down for long.
While neither the BJP nor INC have released any official policy manifestoes, INC has historically delivered growth at the expense of wider fiscal deficits and higher inflation, as indicated in the table below. So, if the opposition did manage to unseat the BJP, we would expect the weighted-average cost of equity and debt capital to rise; bond yields would be higher than the 6-7 per cent range we have seen in recent years, for instance.
More populist policies
In the run-up to the election the BJP has ramped up its populist credentials, with policies like loan waivers and cash support for farmers, minimum support prices for crops, and a nationwide health insurance scheme. Meanwhile, tax collection (especially GST receipts) is likely to fall short by around 0.5 per cent of GDP this year. We estimate these factors combined will lead to a fiscal deficit approaching 3.5-3.7 per cent for the 2018-2019 year, measurably exceeding official guidance of 3 per cent. However, the fiscal profile should improve from 2020 onward as increased tax revenues help finance higher spending.
From an investment perspective, the currency is likely to be weak amid wider deficits, looser monetary policy and election headwinds. A higher supply of government bonds could weigh on yields, but the RBI’s heavy open-market purchase schedule should help set a trading range in the near term. In US dollar credit, the safer companies are more attractively valued now compared to a year ago.
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