Modi’s victory heralds dawn of a ‘new era’ for India

Long before vote-counting officially ended on May 16, Indian equities rallied. Narendra Modi, the son of a tea-seller, seemed ready to win the general election, bringing an end to the Gandhi family’s dynastic rule.

The Bhartiya Janata Party (BJP) captured 282 of 543 parliamentary seats, according to the Election Commission of India. This was more than the 272 seats required. The main opposition, the Congress party, secured just 44 seats, less than a quarter of its previous total.

The result marked India’s first single-party majority since 1984. Equities surged as overseas investors bought a net $196.5m (€143.36m) of domestic shares on May 15 and global funds bought $615m of Indian stocks the following day.

Fund managers, who were earlier bearish on India, excited by the promise of much-needed reforms, are again finding opportunities. “There had been a risk that results would disappoint and that the optimism of recent months would sour,” says Craig Botham, emerging markets economist at Schroders Asset Management. “Instead, the count has surprised to the upside, giving investors a fresh injection of hope.”

There is little doubt among analysts that the new government has a busy schedule ahead. “Over the longer term, inefficiencies in the land and labour markets must be addressed and the tricky issue of foreign investment resolved,” Mr Botham says.

Despite these obstacles, he remains hopeful. “A majority for the BJP greatly reduces the need for compromise and could mean we see reforms pushed through relatively quickly.”

Business leaders backed Mr Modi because of his track-record in the state of Gujarat. During his tenure as chief minister of Gujarat, since 2001, the state quadrupled its per capita income to $1,040, moving faster than the national average by removing policy bottlenecks and attracting foreign direct investment.

Mr Modi’s rise to prime minister, however, has been mirred in controversy, due to his past affiliation to a Hindu fundamentalist party. He is blamed for failing to stop communal riots between Hindus and Muslims during his tenure in Gujarat, which killed an estimated 900 to 2,000 people. However, he has since been exonerated. Several business leaders and intellectuals have chosen to forget the riots and look towards economic development. Investors are hoping he can replicate the Gujarat model countrywide.

If Mr Modi pursues the anti-corruption policies in his agenda, India has the potential to grow 10 per cent annually for the next 20 years, believes Jim O’ Neill, former chairman of Goldman Sachs Asset Management and the man who coined the Brics acronym, grouping India’s emerging economy together with Brazil, Russia and China.

But has the market’s enthusiastic backing of the new political order been overdone? Investors could be forgiven for believing India is starting to look expensive, says Pankaj Murarka, fund manager, Indian equities at Axis Asset Management. But if you look past the short-term election rhetoric, the rally has not been broad-based and has been focused on select sectors and companies, he says.

“Valuations, on the whole, still remain reasonable and as we like to remind investors that India in 2014 is not the same as it was in 2009, when a short-term stimulus and a coordinated global response to the financial crisis delivered quick gains in equities,” says Mr Murarka. “The current recovery in the Indian economy will be more protracted, but bodes well for long-term investors focused on the quality of future growth.”

The BJP’s overwhelming victory has rightly been hailed as the beginning of a ‘new era’ for India, says Sam Vecht, manager of BlackRock BSF Emerging Markets Absolute Return Fund. “We are long-term bulls on India given its entrepreneurial culture, industrious workforce and high savings rate,” he says. “The currently low level of financial penetration and GDP per capita leave plenty of room for future growth.”

BlackRock’s preference is for domestic cyclicals and stocks, especially state-owned enterprises, which would benefit from meaningful government reform, Mr Vecht says. “We note that many of these stocks have gone up substantially in the last nine months, but they continue to offer value and are much preferred to exporters and defensive consumer names.”

After the initial post-poll exuberance, there may be short-term market consolidation as investors adjust to the new landscape, says Ajay Argal, investment manager of the Baring India Fund. “The immediate reaction of the market was to rise on the news of the election result, followed by a degree of profit.”

However, regardless of short-term movements, Mr Argal believes the Indian economy and market will benefit from an economic upturn over the next 18 to 24 months.

“In the coming days and weeks, investors will be watching to see the composition of the next government,” he says. “A smaller cabinet would indicate Mr Modi is opting for a stronger and more decisive government.”

Once formed, he expects the new government will move early to capitalise on the momentum of its victory to push forward reforms. “Mr Modi is likely to take a pragmatic, long-term view with his plans for reform,” Mr Argal says. “He has continually employed the slogan ‘Give me 60 months’ throughout the campaign, and he may even be thinking longer term than this.”