31 Mar 2019
Article | 26 March 2019 | Georgina Taylor, Multi Asset Fund Manager, Henley Investment Centre
Nearly five years have passed since Narendra Modi and the Bharatiya Janata Party (BJP) won the Indian general election by a landslide. The Hindi slogan they had used during their campaign was ‘Achhe din aane waale hain’ (‘Good days are coming’). Modi is now nearing the end of his current tenure as prime minister and is seeking re-election in what is to be the world’s largest democratic exercise. His popularity, however, has waned.
Last December, his party saw a political setback, with major swings against it seen in three key states. It has become abundantly clear that the widely-felt enthusiasm of 2014 has been slowly replaced by disappointment: many people have simply grown tired of waiting for the ‘achhe din’ they believe may never come.
But that disappointment has not grown into outright hostility – and this is an important factor. This means that voters may not tactically vote against Modi and his party in the upcoming general election. One of the problems the BJP has had in the past is that they have not been very good at story-telling. Whilst demonetisation was clearly not a success story, they have yet to create a compelling narrative around the changes they have made to date.
Over the following weeks, the BJP will need to send a clear message on where progress has been made. Providing electricity to everyone has been a key focus of the government, alongside improved sanitation. This month has seen the launch of a cash pay-out scheme for farmers, which aims to offset the decline in food prices. Other initiatives included clearing up the banking system and targeting tax avoidance.
There are several aspects though that tilt the balance in favour of Modi and the BJP. Firstly, there is a lack of credible faces within the alternative parties. Secondly, the recent terrorist attack in Pulwama, and the resulting heightened tensions between India and Pakistan, saw the country’s focus shift onto national security, where Modi has the upper hand. His strong response to the attack has bolstered support at home and increased his chances for re-election.
There have been some stark reminders over the past few years that politics matters, and perceived political risk can have a dramatic effect on asset prices. As the Indian election draws nearer, we need to balance the potential political risk with monetary and fiscal policy to determine whether there are any investment opportunities in the region.
Over the past few years, structural forces have driven a downward shift in India’s inflation and this formed part of our investment thesis for buying Indian assets. A few months prior to the 2014 general election, headline inflation peaked at more than 11%; inflation is now hovering around the 2% mark1, with the more recent move lower having been caused by an oversupply of agricultural commodities and a reduction in fuel prices.
Whilst interest rates have fallen over the past five years, the Reserve Bank of India (RBI) raised rates in 2018 – much to the disappointment of the Indian government. There has been a change in leadership at the RBI with Shaktikanta Das now taking the helm and this year interest rates have been cut. It seems the government views the role of the RBI as adopting a monetary policy stance which dovetails with government policy. The government is reorienting its policies and reforms towards redistributing wealth which could act as a short-term constraint on growth.
Given these policy changes, the dynamics for investing are changing. We believe there are now enough idiosyncratic factors to drive different outcomes for the equity, bond and currency markets – we cannot simply assume that these asset types are going to be positively correlated going forward as they have been in the past.
A second term for the BJP will ensure policy stability and continued implementation of reforms. Should this materialise, the Indian equity markets could perform relatively well. The last week has provided us with a glimpse of this: India’s Nifty index has rallied to its highest level in six months as the recent spike in Modi’s popularity has led to investors pricing in a potential Modi victory.
However, one of the reasons that a positive trajectory for the equity market may not translate into currency strength is that the Indian equity market has more recently been driven by domestic investor flows following the introduction of direct saving schemes. This may in part explain the rise in the Indian equity market last year which was accompanied by a fall in the currency, although higher oil prices also drove the rupee lower.
We have chosen to express a view on India through buying the Indian rupee. Lower inflation is very supportive of the currency and higher interest rates versus other economies around the world also provides some support for the currency going forward.
However, we will need to keep a keen eye on the inflation trajectory over the course of the year. The RBI targets headline inflation, which is currently low because food prices have fallen significantly. Farmers are being asked to produce more food each year as they have done historically, but that growth in the food supply in certain areas such as rice is causing an oversupply of food because of the change in eating habits of the population.
Core inflation (which excludes the impact of food and energy) is higher than headline inflation, which is very unusual. We believe this is a cause for concern as it increases the risk of a policy mistake. If the RBI continues to cut rates, there is a risk that underlying core inflation continues to increase. This raises the risk that India starts to lose control of inflation again, which would be negative for Indian asset prices.
From a broader investment perspective, the government continues to enforce limits on foreign investment in government bonds, and there are currently no plans to open the market up any further. They believe this is important for insulating the Indian economy from global forces.
There are other global pressures they cannot control, such as oil prices. Because India is a net importer of oil, higher oil prices are deemed to be negative for the economy and this often translates into a fall in the Indian rupee. Going forward there is a suggestion that the government will actively look to reduce their country’s sensitivity towards oil and hedge their exposure, which would impact one of the core drivers of Indian asset prices and therefore, this is something we need to watch closely.
India will head to the polls over a five-week period from 11 April to 19 May. The BJP’s new slogan for the upcoming general election is ‘Modi hai toh mumkin hai’ (‘With Modi, everything is possible’). Should the BJP indeed win the upcoming election, they must not remain complacent – they have to move beyond soundbites and convey their achievements to the electorate, should they want to stem the flow of discontent. If the BJP is successful, this should be supportive for India and we believe one of the best ways to express this positive view is via the currency relative to other Asian currencies such as the Taiwanese Dollar.
1 Source: Bloomberg as at 28 February 2019.
Investment risks
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