You are using an older browser version. Please use a supported version for the best MSN experience.

Modi, markets and the economic disorder

LiveMint logoLiveMint 30-05-2014 Niranjan Rajadhyaksha

The mood in trading rooms has dramatically changed in recent weeks. The tone of equity strategists’ reports seems much less glum. And the usual suspects are already on television predicting a new bull run. The Narendra Modi victory has electrified the stock market.

Each of the three most recent election results has been greeted very differently in the markets on the day the votes were counted. The unexpected defeat of the National Democratic Alliance in 2004 followed by the prospect of a Congress government dependent on support from the Left Front led to a wave of panic selling. The surprisingly strong victory of the United Progressive Alliance (UPA) in 2009 had sent share prices soaring in a market that was still feeling the aftershocks of the global financial earthquake. The massive Modi victory this month saw markets shoot up in the early hours of trading but then give up most of these gains by the end of the day. The response was thus surprisingly muted. Investors were quick to book profits.

One possible reason is that markets had read the electoral tea leaves better than political pundits. Buying had started much before it even became clear from opinion polls that Modi would be in a good place when votes were counted. It is thus quite possible that the brokerage houses that had sent their analysts through India to gauge the political mood had done a better job than even professional journalists who are supposed to be good at such analysis. The other possibility is that Indian shares had gained as part of a broader rise in equity prices across emerging markets as global risks were seen to be receding.

Data on stock market returns from a month before election results in 2004 and 2009 to a month later shows there was no directional change. The actual day of counting saw dramatic movements in share prices. But equities drifted lower in 2004 while they drifted higher in 2009. We will know the record for 2014 soon.

A look at stock market returns across 10 major emerging markets shows that India has been one of the best performers since the beginning of the new fiscal year. Only Turkey has done better. The other eight markets I have considered are China, Brazil, Russia, South Africa, Mexico, Indonesia, Nigeria and the Philippines. It is very likely that the biggest reason for Indian outperformance is the prospect of a more decisive government led by Modi in New Delhi. Several other financial parameters also indicate how investors are growing more confident. The National Stock Exchange VIX Index that is based on the implied volatility of options has fallen very sharply since the election results were announced, a sign of receding fear. The risk spreads on Indian corporate bonds listed abroad have narrowed over the past month. The premium on the credit default swaps on the bonds issued by ICICI Bank Ltd has also fallen. Global capital continues to pour into Indian financial assets.

The renewed confidence does not necessarily mean India is on the verge of a quick economic turnaround. Persistently high inflation means the central bank is unlikely to bring down interest rates in a hurry. The public finance mess does not leave the new government with much freedom to ramp up spending to stimulate economic activity. Many companies are weighed down with debt while the return on capital employed of large companies is far lower than what it was during the boom years. And banks have a massive bad loan problem.

I had asked in these pages in January whether India is headed for a Thatcher moment, when old consensus would be overturned by a political entrepreneur who appeals to an angry electorate: “The big question is whether India is approaching a political inflection point similar to the one seen in Britain in 1979, a desi Thatcher moment. Will the next government try to correct the situation while staying on the old path, or will it try to take India down a new course?”

“There is no doubt that Modi is trying to craft a new political narrative that seeks to replace the one that the Congress has propagated over many decades. His statements on the role of government and governance are perhaps the most radical ones heard in Indian politics since the heyday of the Swatantra Party. Modi has also tried hard to build a new political narrative using a diverse cast of leaders from Vallabhbhai Patel to Shyamji Krishna Varma, though these attempts have been marred by factual errors that would make a college student cringe...”

“The barons of Congress socialism, Lohiate caste politics and regional power brokers are still a powerful force in Indian politics. But the beauty of revolutions or inflection points is that they are fundamentally unpredictable. The combination of an economic downturn, voter angst and new political narratives offer a sliver of hope that India could be tantalizingly close to a Thatcher moment.”

Modi inherits an economic mess and deeper structural problems that cannot be solved in a day. It is worth remembering that Margaret Thatcher and Ronald Reagan had to fight hard battles in their initial years. They backed brutal monetary compressions that killed inflation but also put so many people out of jobs that their political careers were under threat. The point of providing this example is not to argue that Modi needs to do the same but that radical change is rarely a smooth affair. It is a historical fact that investors don’t seem to be taking into their calculations.

More From LiveMint

image beaconimage beaconimage beacon