Most investors have priced in Prime Minister Narendra Modi winning a second term in the 2019 national election. A change in expectations through this year could derail a rally that’s almost doubled the nation’s equity values since PM Modi took office four years ago.
UBS Securities India Pvt. says the optimism about the government’s economic agenda has helped investors brush off weak earnings. And the expensive equity valuations underpin the market’s hopes for PM Modi returning with a single-party majority, analysts led by Gautam Chhaochharia wrote in a note dated Feb. 23.
While not trying to predict the election outcome, UBS is recommending that investors keep an eye on three dynamics to track the event.
India has a first-past-the-post system, which gives the candidate with the most votes in a constituency a seat in government. Hence, degree of opposition fragmentation is key. The ruling BJP may not have won a majority in 2014 had key opposition parties joined hands, the analysts wrote. “If this were to happen in 2019, a majority would be tough and outside support would be needed to form the government.” So, monitoring potential alliances of opposition parties is key.
The performance of PM Modi’s party in the eight state elections this year will also be a pointer for market sentiment, the analysts wrote. In December, the BJP held on to power in PM Modi’s home state of Gujarat with its lowest seat tally in about two decades. The BSE Sensex slid as much as 2.6 percent before recovering on Dec. 18 when votes were counted.
“State election results don’t suggest any material impact on BJP’s standing,” the analysts wrote, noting that their calculation “is simplistic, as it does not consider differences in voting patterns for state and national elections.” Opinion polls for states going to elections this year may also receive market attention, more so if the possibility of holding early general election increases, the analysts said.
In 2004, the BJP-led government of Atal Bihari Vajpayee held national elections before its term ended and lost that election. The Sensex crashed as much as 17 percent when votes were counted on May 17 that year.
The rupee, already Asia’s second-worst performer, could also see a jump in volatility closer to event.
“With the election still 12 months away, only one thing is clear: uncertainty (either around the timing or party agenda),” the analysts wrote. “If portfolio flows slow due to election uncertainty or the recent rise in U.S. inflation (and yield), then the rupee could come under pressure.”
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