Much to the surprise of market watchers this week, India’s Bharatiya Janata Party (BJP), led by incumbent Prime Minister Narendra Modi, failed to achieve an outright majority and will now have to rely on the support of its allies within the National Democratic Alliance (NDA) to form the next government.
The BJP lost some 60 seats, marking its worst electoral performance since coming to power in 2014.
On Monday, ahead of the vote count, benchmark BSE Sensex and Nifty50 indices hit intraday record highs off the back of pre-polls suggesting an overwhelming majority for BJP.
However, following the surprise result, the NSE Nifty 50 Index fell by some 1,379.40 points, ultimately recovering to around 21,884.50 at close on Tuesday. The S&P BSE Sensex, too, dropped to 72,079.05, a decline of 4,389.73 points.
Such fierce declines had not been seen since the beginning of COVID-19 lockdowns in March 2020.
“With the BJP now dependent on NDA allies to form a government, we think markets will take more time to gain confidence in the stability of the new government and the policy mandate that the government will follow,” Barclays analysts said in a market note.
“In this respect, we think the cabinet formation and the Union Budget (expected in July) will be the next milestones the market will be watching.”
The bank highlighted the potential risk of legislative gridlock due to a more united opposition to the NDA government, suggesting that checks and balances on the government are expected to become more stringent.
Despite this, the risk to policy priorities is forecast to be relatively low, as the emphasis on crucial infrastructure projects such as roads, housing, railways, and manufacturing is expected to persist.
The recovery in private investment, however, may be slightly delayed, it observed, “with domestic and foreign investors, and businesses, pausing to gauge policy priorities and the stability of a BJP-led coalition-government”.
Barclays forecasts the resilience of the Indian rupee to endure but said the USDINR implied volatility curve could stay elevated in the near term.
The analysts also believe that, while equity sentiment is likely to simmer over the next few days, foreign flows into Indian equity markets are likely to resume, after the dent creates better entry levels.
They also predict that FII and FDI will pick up as global investors increase India exposures.
“India provides an attractive alternative in EM, given its relatively attractive carry/vol ratio especially within the region, relative stability in the currency and still low foreign ownership of domestic assets,” Barclays said.
On the fixed income side of the market, the analysts noted that fundamentally, “the macro backdrop for bonds is already improving, albeit gradually”.
“Inflation is moving in the right direction, with core inflation moderating since May 2023 and hitting a series low in April.
“Notwithstanding policymakers likely to lean on the side of caution on the last mile of disinflation – with a focus on the upcoming monsoon season and food prices, we expect a window for RBI rate cuts to open up in December given the current inflation trajectory.”
May need to reset ‘lofty’ expectations
Federated Hermes’ head of global emerging markets, Kunjal Gala, also predicts some uncertainty could hurt equities in the short-term. However, over the medium term, Gala said the prospects for stocks “will depend on earnings trajectory”.
“Partly, this will depend on recovery in the rural/farm sector, the government’s investment plan, and revival in private sector capex, which will boost overall job creation in the economy.
“Suppose the coalition politics result in any policy rollbacks or concessions, or any deviation in policy resulting in fiscal issues – in that case, there is likely to be an increase in volatility impacting stock performance.”
According to the investment executive, the shape of the next government, including its choice of ministers and the upcoming budget statement, will be important indicators to assess India’s macro trajectory.
Presently, Federated Hermes remains underweight in India, noting a lack of a margin of safety in valuations, among other concerns.
Gala added: “We remain opportunistic and will assess companies in our inventory that we could not invest in the past due to high valuation as the situation becomes apparent on the political/macro front.”
