India’s next general election presents a tail risk as the market is unsure if the world’s largest democracy will re-elect a majority government for the second straight term.
That risk is even more pronounced this time, according to Morgan Stanley Research. History suggests that markets approach general elections with a tinge of optimism and stocks tend to do well in the run-up to elections, Ridham Desai and Sheela Rathi, analysts at Morgan Stanley India, said in a report. However, they wrote, there is a major change versus history for the next year’s general election.
“Since 1991, every election has been preceded by a coalition government; hence, the market has had room to be hopeful of a stronger government,” Morgan Stanley said. “It enters the 2019 polls with a majority government already at the helm. So, it has to deal with the prospects of a weaker government at the centre.”
Prime Minister Narendra Modi’s ruling Bharatiya Janata Party has faced challenges in the past year as growth slowed to its lowest in three years after the cash ban and Goods and Services Tax rollout. Even as the economy rebounds, the government has run into a Rs 14,000-crore fraud at the Punjab National Bank, India’s second largest public-sector lender. Two recent sexual assault cases in Uttar Pradesh, where the BJP is either in power or shares it with a partner, has also left it red-faced. A return with a majority can no longer be taken for granted.
The research house advises a barbell approach, mixing defensives and cyclicals, with a focus on large-cap at a reasonable price. Accounting for a range of possibilities, it also built indicative portfolios for investors factoring in four possible scenarios after the general election.
Morgan Stanley Research’s worst-case scenario is a weak coalition with a lead party supporting from outside. That will leave the next “government vulnerable”. If such a risk increases, stocks will fall, it said.
Here are the possible scenarios and the portfolio approach to elections:
There’s an absolute majority, with either of the national parties winning more than 260 seats. This would be similar to BJP’s win in 2014. Investors can go slow on defensives if they expect such a scenario, according to the report.
A weak majority for one of the national parties, that is, with more than 220 seats but less than 260. Morgan Stanley recommends more of consumer staples and discretionary, information technology and materials stocks.
A weak coalition with the lead party winning 180 seats. India has seen such governments in 1998 and 1999 with Atal Bihari Vajpayee as the prime minister both times. “Coalition governments do not necessarily lead to poor growth – but they can adversely affect sentiment in the short run,” the report said. In such a case, investors can bank on consumer staples, information technology and utilities.
A weak coalition with a lead party only participating in a supportive capacity. “Such support is from the outside leaving the government vulnerable,” the report said. Investors should be underweight on consumer discretionary, energy, financials, industrials and materials.
Here’s the average of Morgan Stanley’s all possible portfolios.
What Will Determine The Election Outcome?
With 15 months left to the polls, Morgan Stanley also outlines four factors that are likely to determine the prospects of Modi's re-election.
- Real Growth: While India's economic growth recovered to 7.2 percent in the last three months of 2017 after falling as low as 5.7 percent after demonetisation, it is
“not strong enough for this position [BJP’s majority] to be totally secure”.
- Youth Voters: India’s youth is likely to decide the outcome of the elections with 250 million voters between the age of 18 and 28. BJP won the previous election with 172 million votes. “This sets the stage for a technology-intensive election campaign.”
- Alliances In Uttar Pradesh And Maharashtra: The two states account for 128 seats out of a total 543 in the lower house.
- The Eight Indicators: Two-wheeler sales, tractor sales, rural wage growth, consumer price inflation, minimum support prices, farmer well-being, direct benefit transfers and jobs growth. “If these indicators are in good shape in the coming months, that would enhance the prospects of re-election of the BJP-led NDA,” the report said.
An election will play a key role since Indian elections are fought over well-defined issues—and, sometimes, single ideas like corruption alleviation in BJP’s 2014 election campaign, Morgan Stanley said.
Public slogans are important—they define the social and political debates -and will determine the behavior of parties in the coming months.Morgan Stanley Research