Indian stocks lagged behind those of other major emerging economies for much of the first quarter, but have since caught up. Since the mid-March low, the benchmark Sensex index has risen by 35% as global risk appetite has improved, while investors hope further interest-rate cuts will ensure that the economy bottoms out soon.
But the economic outlook remains murky, and the ongoing general election (voting began last week and will end on 16 May) is a source of uncertainty in the near term. “The result should be keenly watched by international investors,” says Una Galani on Breakingviews.
Investors had hoped that India would be largely shielded from the global downturn, given that its dependence on exports – around 15% of GDP – is the lowest in the region. What was forgotten, however, was Indian firms’ reliance on capital inflows from abroad to finance investment, the main driver of GDP growth over the past few years.
With money from abroad now dried up and domestic banks also cautious (the prime lending rate at the top five major banks has eased by just 2% over the past year, while the main interest rate has been slashed, says Capital Economics), investment and credit growth have fallen. Non-food credit growth has slipped below 18% year-on-year for the first time in five years, says Standard Chartered. Given a budget deficit heading for 10%, there’s virtually no scope for government spending to shore up growth.
GDP looks set to expand by a mere 4% this year, reckons Capital Economics, a far cry from the 8%-9% pace of recent years and, bar 2001, the lowest since economic reforms were launched in the early 1990s.
Investors appear to “have assumed that the worst for earnings has been plugged into consensus estimates and hence share prices”, says Ridham Desai of Morgan Stanley. The bear market “will only be over when earnings improve”. For now, the most likely scenario is a slide in profits of 10% in the 12 months to March 2010, compared to the -1% pencilled in by the consensus.
Currently, the market’s biggest problem is the election. “The speed of India’s recovery is at stake,” says Galani. The “right government” could help win back foreign direct investment – down by 73% year-on-year to February – which would underpin growth. Investors have been disappointed by the current government’s pace of structural reform: an “unruly coalition” has blocked much of the Congress Party’s agenda. Like the opposition BJP, which is also reformist, its support has fallen over the past few years, “strengthening the hand of less market-friendly” forces.
The danger is that the election will result in either a weak, broad coalition or a “third front” government led by communists. Either outcome could “potentially reverse the march to reform”. Desai reckons that the odds of a weak coalition (possibly supported by leftist parties) or a third front government are more than 50%.
But political jitters may be overblown. As Vinay Gairola of the Atlantis India Opportunities Fund points out, any government will have to continue its predecessor’s policies if it’s to ensure growth is strong enough to allow the 18 to 20 million graduates produced every year to find work.
Whatever the outcome, the uncertainty over the next few weeks seems likely to hamper stocks. Desai notes that on average over the past four elections the Sensex has performed well before the vote, but ended up around 15% lower eight months afterwards.