Modi: not out?

Ewan Thompson, manager of Neptune India Fund, comments on the recent volatility in the Indian equity market.

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  1. Ewan Thompson

Investing in India over the past 18 months has been somewhat turbulent. In general, India has outperformed wider emerging markets in recent years, but in the last few months it has been a bumpy ride, with performance being driven by a combination of external macro drivers and domestic political considerations.

First the macro: once labelled as one of the Fragile 5 emerging market economies in 2013 during the Taper Tantrum, India had enjoyed a recovery in fortunes as the Central Bank worked to rebuild currency reserves and policy makers addressed the current account deficit that had left the economy so fragile. However, one of India’s key external exposures remains its status as an oil importer and thus vulnerability to rising energy costs. It was the rally in crude oil prices above $80 per barrel in September last year that sent the Indian market sharply tumbling along with the rupee. However, India has also suffered a degree of domestic uncertainty in recent months, especially connected to the upcoming elections this year.

In April and May nearly a billion people will go to the polls in India’s General Election. Famously, the election of 2014 – which saw the victory of Narendra Modi’s Bharatiya Janata Party (BJP) – saw a sustained rally in Indian equities on expectations of a pro-business government policy agenda. Indeed, four out of the last five elections have seen strong market performance in the run-up to the event because investors had become frustrated with coalition government and hoped for an administration with a clear mandate for reform. Although the upcoming election is unusual in that the current leadership is not a hamstrung collation, the outcome remains important as to whether India will remain under a reform-led BJP government with a clear mandate. To this end, many investors had responded negatively to polling suggesting an unclear outcome – this in large part explains the weak performance of the Indian market in the past months.

However, all of this has recently changed in the final run-up to voting – in large part a response to the recent military spat with Pakistan over Kashmir. In the wake of a bomb attack on an Indian army convoy on 14 February, events have led to a surge in support for the government and expectations for a BJP victory – with the market rallying robustly. Indeed, since mid-February, $6bn of foreign inflows have surged into the market in just one month, eclipsing the $4.5bn of inflows during the entirety of 2018. This improving domestic political outlook has also come at a time where US bond yields have eased significantly and the ascent in the US dollar has been checked, both of which supporting emerging markets in the early months of this year.

With inflation running at an extremely low level of just 2%, the Reserve Bank of India also has plenty of room to cut interest rates and stimulate credit growth, offering a favourable domestic economic backdrop to support the market. With the improving external backdrop as well as clearer domestic political outlook, India has had an opportunity to recover recent underperformance against wider emerging markets and all eyes will now be on the election, the results of which are due in late May. The market is now clearly hoping for – and expecting – a decisive BJP victory and therefore continuation of market-friendly reform policies that have begun in Modi’s first term.

Ewan Thompson is manager of Neptune India Fund.

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