A man walks past a bronze bull statue outside the Bombay Stock Exchange building in Mumbai, India, on June 3. Photo: Bloomberg
Opinion
Macroscope
by Nicholas Spiro
Macroscope
by Nicholas Spiro
Will Modi’s election setback end investors’ love of India?
With policy continuity likely in New Delhi, strong fundamentals intact and pressure on the government to create jobs, investor optimism may well be justified
Financial markets are notoriously bad at assessing and pricing political risk accurately. In the days leading up to India’s general election results, announced on Tuesday, the benchmark Nifty 50 stock market index hit a record high.
Exit polls pointed to an emphatic victory for Prime Minister Narendra Modi’s Bharatiya Janata Party (BJP) and its smaller regional allies, providing a fillip to sentiment that has been resoundingly bullish since the Covid-19 pandemic.
When it emerged that the BJP-led alliance’s victory was not only much narrower than forecast but that the BJP itself had lost its parliamentary majority, forcing it to rely on its allies to govern, stock markets plunged. The Nifty 50 fell nearly 6 per cent, its steepest daily decline in more than four years. A staggering US$386 billion was wiped off the value of Indian shares.
The shock result is a kick in the teeth for pollsters. For markets, it is a reminder that complacency can be costly. Yet, foreign institutional investors – whose bullish views were responsible for increasing India’s weighting in the benchmark MSCI Emerging Markets Index from less than 8 per cent in March 2020 to 18 per cent today – had already turned more cautious before the election, selling shares.
Last year, overseas investors bought a net US$21.7 billion worth of Indian stocks, accounting for 55 per cent of foreign purchases of equities in Asia excluding Japan, according to data from HSBC. However, this year, they have been net sellers of Indian shares. Large outflows in the past two months have reduced the ratio of foreign ownership of the country’s stock market to less than 18 per cent, its lowest level since 2012.
03:14
Modi’s BJP claims ‘historic’ victory in Indian election despite smaller majority
Modi’s BJP claims ‘historic’ victory in Indian election despite smaller majority
While several domestic and external factors are at play, the most important is that foreign investors believe “peak India” has been reached. This will make it increasingly difficult for the stock market to continue to outperform.
India is already the world’s most expensive major equity market, with a forward price-to-earnings ratio that is even higher than the technology-heavy US market. Lofty valuations are partly justified, given high earnings growth, the fastest rate of expansion among the world’s leading economies, huge catch-up potential and the geopolitical sweet spot India has occupied in recent years.
Yet everything is relative, especially in markets. India’s attractiveness was accentuated by the dramatic deterioration in sentiment towards China. “India offered a gleam of hope for [emerging market] investors as growth prospects turned gloomy in most of the large [developing] countries,” Societe Generale notes.
Sentiment is shifting, though. Although many foreign investors remain resolutely bearish on China, others have become more optimistic this year. Morgan Stanley says that while China is “still structurally challenged”, it is “stabilising cyclically” just when India’s economy and its companies’ performance are under pressure. Earnings growth this year is expected to be slightly stronger in China.
02:27
One family, one polling station: remote Himalayan villagers cast votes in Indian general election
One family, one polling station: remote Himalayan villagers cast votes in Indian general election
With Modi’s narrower-than-expected victory giving rise to a more uncertain political and policy landscape in India, a stock market that has been priced for perfection now looks more vulnerable. Many of the risks that have unsettled investors – expensive valuations, threats to political stability and policy continuity, and insufficient resolve to implement crucial reforms to tackle the country’s severe employment crisis – have suddenly become more acute.
Could the net outflows of foreign capital from India’s stock market be a taste of things to come? Not so fast. While last year’s surge in foreign inflows reinforced the bullish narrative, they masked a domestic liquidity boom, a more important driver of the world’s fifth-largest equity market.
Since the beginning of this year, local institutional investors have bought US$25 billion worth of Indian shares, extending a long period of almost uninterrupted inflows. However, it is retail investors who are powering the rally. While foreign funds’ net positioning in derivatives markets reached its most bearish level on record before the election, individual investors turned the most bullish ever, according to data from Bloomberg.
Yet it is the rapid growth of India’s mutual fund industry that has turbocharged the stock market. Monthly payments into mutual funds through “systematic investment plans” have caused the funds’ assets under management to swell to US$600 billion, two-thirds of which is in equities, according to Societe Generale.
Supporters of the Bharatiya Janata Party wait outside the party’s headquarters during election results night in New Delhi on June 4. Photo: Bloomberg
Just as importantly, mutual funds are gaining market share from other categories of investors and are a stabilising force in India’s stock market during periods of intense selling pressure. Although excessive speculation by retail investors in smaller stocks can incur the wrath of regulators, domestic investors are underpinning India’s bull market.
To be sure, a sizeable proportion of individual investors are likely to have voted for the opposition parties. Modi’s authority has been damaged and parts of his economic agenda have been found wanting. Voters have brought the weaknesses and vulnerabilities of India to the fore.
However, the investment case for Asia’s third-largest economy remains compelling. Enviably strong cyclical and structural tailwinds, an infrastructure boom, world-leading information technology and service sectors, and eight straight years of stock market gains are a powerful combination.
Foreign investors were right to be more cautious ahead of the election, but it is domestic investors who will determine whether India’s bull run persists. With broad policy continuity virtually assured, strong fundamentals still intact and more political pressure on the government to create more jobs, their optimism looks justified.
