India's Financial Markets Brace for Volatility as National Elections Loom

Key Takeaway

• India's financial markets face potential volatility as national elections approach, with $6.3 billion already pulled by foreign investors this quarter.
• A strong BJP showing could ease investor concerns and support the rupee, while a weaker result may lead to further outflows and pressure on the currency.
• Domestic investors remain influential, with the NSE Nifty 50 Index signaling potential gains; RBI's record dividend transfer provides fiscal flexibility.

Election Outcome Uncertainty

India’s financial markets are facing potential volatility as the country approaches its national elections. Prime Minister Narendra Modi’s Bharatiya Janata Party (BJP) is aiming for a significant majority to push through extensive reforms, including overhauling land and labor laws. These reforms are seen as crucial for Modi’s vision of transforming India into a developed nation by mid-century. However, a slimmer majority for the BJP could complicate these plans.

Khoon Goh, head of Asia research at ANZ Group Holdings Ltd., noted, “Should the election outcome throw up an unexpected result, this will likely see investors turn more cautious and lead to further outflows, putting pressure on the rupee.” The rupee has been trading near a record low against the dollar, and any political uncertainty could exacerbate this situation.

Foreign investors have already pulled $6.3 billion from Indian stocks and bonds this quarter, reflecting concerns about the election outcome. The India VIX Index, a measure of expected market volatility, has more than doubled since April, indicating heightened investor apprehension. Michael Wan, a currency strategist at Mitsubishi UFJ Financial Group Inc., commented, “If the BJP loses some seats, there will probably be some knee-jerk weakness” in the rupee and risk assets.

Market Reactions and Investor Sentiment

The market's reaction to the election results will be closely watched. A strong showing by the BJP could ease investor concerns and support the rupee. Goldman Sachs Group Inc. and Societe Generale SA have both indicated that a third term for Modi could boost foreign interest in local shares, which would, in turn, bolster the currency.

“There is still scope for the RBI to let the rupee appreciate by 1%-1.5% to signal a positive market reaction if the election results point toward a stable government,” wrote Bank of America Corp. strategists, including Claudio Piron, in a recent note.

Domestic investors have been a significant force in the market, surpassing foreign investors in terms of market direction. The NSE Nifty 50 Index recently broke out of a double-bottom pattern, signaling potential further increases in the coming weeks. The Reserve Bank of India (RBI) also announced a record dividend transfer of 2.1 trillion rupees for FY2024, providing the government with additional fiscal space that could be used to boost spending or reduce the fiscal deficit.

Reform Agenda and Economic Impact

Modi’s government has been credited with several significant reforms, including the implementation of a nationwide sales tax and advancements in digitization. However, some critical reforms, such as labor and agricultural reforms, were deferred due to political backlash.

“There are definitely a few important tasks on Modi’s to-do list, which he hasn’t completed yet, which would be an awful lot easier if you had a thumping majority,” said Rob Brewis, investment manager at Aubrey Capital Management Ltd. “For India to continue to accelerate growth rates, these big reforms are needed.”

Finance Minister Nirmala Sitharaman recently stated that the new government would undertake over 100 fresh policy reforms in the first 100 days after taking office, although details were not specified. Land and labor reforms will require consultation with states, adding another layer of complexity.

Street Views

• Khoon Goh, ANZ Group Holdings Ltd. (Cautiously Optimistic on the Indian market):

  "Should the election outcome throw up an unexpected result, this will likely see investors turn more cautious and lead to further outflows, putting pressure on the rupee."

• Michael Wan, Mitsubishi UFJ Financial Group Inc. (Neutral on the Indian rupee and risk assets):

  "If the BJP loses some seats, there will probably be some knee-jerk weakness in the rupee and risk assets."

• Venugopal Garre and Nikhil Arela, Sanford C. Bernstein (Cautiously Optimistic on India's reform execution):

  "India has a lot of catch-up with several Asian peers... With India moving from the reform cycle to the execution cycle, continuity of power remains a crucial driver."

• Rob Brewis, Aubrey Capital Management Ltd. (Bullish on India's growth potential with reforms):

  "There are definitely a few important tasks on Modi’s to-do list... For India to continue to accelerate growth rates, these big reforms are needed."

• Claudio Piron et al., Bank of America Corp. (Bullish on INR appreciation if stable government forms):

  "There is still scope for the RBI to let the rupee appreciate by 1%-1.5% to signal a positive market reaction if the election results point toward a stable government."

Management Quotes

• Patricia Urbano, Edmond de Rothschild Asset Management:

  "A large majority could accelerate reforms and decrease perception of India risk... Less of a margin will require some negotiations [and] alliances."