The waiting game

The BJP is the favourite of India’s big industrialists, and local stock markets have factored in the right-wing party’s expected success in the election. But at a challenging time for the Indian economy, the victor will need to tread carefully in its first budget.
He liberalised India’s economy in 1991 but outgoing Prime Minister Manmohan Singh oversaw India’s worst economic position in decades last year.
By Courtney Trenwith
Sun 11 May 2014 09:43 AM

Since the beginning of the year, India’s two main stock markets have rallied to record highs, the rupee has put on more than 2 percent, and billions of dollars have been ploughed into the country by foreign investors.

While there has been some fall back since late April as investors cash in on profits and show a degree of caution ahead of election results, the message has been clear: investors expect a stable, pro-market government to be installed in India on May 16 – most likely led by Narendra Modi.

Modi is the clear preference for business. Gujarat, where he has been chief minister for 15 years, has repeatedly recorded double-digit growth, out-performing the rest of the country, on the back of economic reforms that have built up industry and attracted foreign direct investment.

On the national stage, the BJP has promised to create 250 million much-needed jobs in the next 10 decade, construct 100 “smart cities” and build a high-speed rail network.

Despite concerns Modi has left behind the Gujarati poor, the BJP’s manifesto is attractive.

It’s even more alluring considering India’s predicament less than a year ago.

In August, the rupee sank to a record low of Rs 68.85 as it became clear the current-account deficit had ballooned out to almost 5 percent (it is now about 2.3 percent), and, coupled with a fiscal deficit, concerns were expressed that India may face a balance-of-payments crisis.

That headache was exacerbated by fears the US was preparing to pull back on its monetary stimulus, plus rising inflation and a significant drop in private corporate investment. Growth was at half of what India had been recording for the previous 10 years.

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The world’s tenth-largest economy was in dire straits. Thanks to the government’s quick action to cut back on expenses, encourage investment and crack down on gold imports, confidence began to return.

It has been even further bouyed by the election and an expectation that a new government will be formed.

The rupee is now comfortably hovering around 60 to the dollar, while India’s largest stock exchange, the NSE, has climbed more than 6 percent since January, after declining from a record high on April 23.

Analysts are no longer talking about doom and gloom. Instead, they’re excitedly watching the pendulum shift in completely the opposite direction.

“As it became clear that Modi and the BJP were going to come into power, you saw this uptake in the stock market, largely reflecting that there was some uncertainty,” Neil K. Shenai, a professor at the American University School of International Service, says.

“In emerging markets, electoral uncertainty is probably one of the biggest sources of political risk.”

The head of currency trading at HDFC Bank in Mumbai, Ashtosh Raina, says investors have become increasingly active on the expectation of a “strong and stable” government coming to power with the willingness to introduce positive economic policies.

“The market is factoring in a favourable result for the markets, so that’s why they’re rallying,” Raina says. “We’re [now] seeing some corrections before the final results come. But after the elections it can go either way because a lot has [already] been factored in.”

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Raina says the biggest issue has been a lack of decision making and stability, affected by the government having a lack of majority in the parliament.

“If that part is overcome, we can have a really good economy; they need to better manage the economy,” he says.

Worth $1.7 trillion, the Indian economy is the tenth largest in the world by nominal gross domestic product (GDP) and third by purchasing power parity, according to the International Monetary Fund. It accounts for more than 6 percent of the global economy, according to data released last month by the 2011 International Comparison Program, which involves the World Bank.

India’s Central Statistics Office estimated in February that GDP in 2013-14 would grow at 4.9 percent, an improvement on the year before but well below the 7 percent average recorded annually between 1993-4 and 2003-4, and the 8.5 percent during 2004-5 and 2009-10.

Since economic liberalisation in 1991 – led by then-finance minister and retiring prime minister Manmohan Singh – growth has soared across most of the country, with many states growing at double-digit rates, enabling countless Indians to be hauled out of poverty.

But while there has been a significant reduction in poverty across India, the disparity between rural and urban areas has widened, according to various data. And India’s GDP per capita is just $4,000, ranking it 168th in the world.

For millions of India’s 1.2 billion people – including the 270 million estimated by the government to still live on or below the poverty line – the price of household items such as the humble onion are a far more important economic indicator.

That was evidenced in October last year when the price of the vegetable blew out by more than 300 percent to nearly 100 rupees ($1.65) per kilo in just weeks and caused angry protests and calls for the government to do something - anything.

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Food prices are a potential election issue for millions of Indians. In 1998, the BJP was booted from power in Delhi when it was unable to control the rising price of onions, a cooking staple.

India still subsidises its agriculture industry, the lifeblood of millions of Indian farmers, and oil, by delaying passing on international fuel price increases.

So not all Indians view the BJP, with its industrial backing and right-wing policies, as the stand-out choice at an election.

“The BJP are only building development for a few - the industrialists,” a Delhi hotel driver says.

“All the things are growing more and more expensive. Modi says he will reduce this, I don’t think he will reduce it. For example, I get this water bottle for 10 rupees, Modi can’t reduce the price to 5 rupees or 8 rupees, it’s impossible.

“He’s spending a lot of money on [campaigning for] the elections, so when he becomes PM these things will be expensive because he’s getting the money from the industrialists, the businessmen, so those products will be expensive to cover that money.”

But the polls do suggest a Modi win and if that occurs, analysts expect the markets to remain stable with small improvements for the time being.

Raina expects the partially pegged rupee to continue to appreciate if the BJP wins, but only “to a certain level”. It won’t go beyond 58, he says.

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Private bank Coutts has forecast it to appreciate a little further, to 59 by the end of 2014 and 58 by the end of 2015.

The Reserve Bank of India, under new governor Raghuram Rajan, signalled at the end of April it would not allow the rupee to appreciate beyond 60 to the dollar, suggesting it would buy up dollars to stabilise its own currency.

Shenai says the expectation of a Modi win is so high there will be little room for market movement if he does become prime minister.

“I think the immediate-term effect on the market might be somewhat muted, provided that in the first couple of days the Modi administration doesn’t institute sweeping national economic reforms that the market hates,” Shenai says. “There’s no short-term risk from the Modi government winning. But the long-term risks are quite acute in a country like India.

“In a democracy, politicians feel an immense need to dole out political favours [and] subsidies to the public to stay in office, and the risk is India has always been pulled in these two directions since independence. There’s been this protectionist, anti-capitalist strand, which looks inward and towards the state for growth and then there’s the kind of outward, market orientation and I think that’s what Manmohan Singh really represented.

“The worry, I would say, is that if Modi comes to power with a tremendous electoral mandate and the Indian economy slows acutely, which it very well could, then there might be a kind of instinctive push on behalf of the government for more intervention, more subsidies, more protection. And as we’ve seen time and time again, that’s what caused massive macro-economic problems right after World War Two and after independence.

“That’s the risk, that India won’t get out of this populist cycle.”

India also is hugely influenced by the global economy, particularly US policy, and any increase in interest rates there will likely negatively affect emerging economies including India.

With such a large agricultural industry (it accounts for about 16 percent of GDP), any significant weather pattern also can have devastating consequences.  Several reports, including by HSBC and Bank of America Merrill Lynch, have warned that an El Nino-induced below-normal monsoon in India this year could hamper economic growth and drive up inflation, with a shortage causing food prices to rise.

But at the top of the new government’s agenda will be the need to contain inflation and create jobs. Finance Minister P. Chidambaram says India needs annual economic growth of about 8 percent in order to create sufficient jobs for its booming youth. More than half the population - that’s 600 million people - are aged under 25. About 100 million of them are voting for the first time at this election.

Whoever forms government this week will face their first test when the budget is handed down in June or July. Any surprises are sure to send markets fluttering again.

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