The clear electoral triumph of the Indian Bharatiya Janata party raises some doubts for investors who last year had bet, albeit moderately, on the launch of reforms in Japan and China. The markets are clearly euphoric at the moment. Sensex, the benchmark of the Indian equity market, is up year-to-date (in US dollars), as are hard currency bonds and the currency, which go hand in hand. So should long-term investors take advantage of this trend? Our answer is yes, and we base that belief on the following four reasons.
1) The dominance of the BJP party could last longer than one might believe. Young voters who cast their first vote for a party in an "anti-establishment" election usually tend to stick with that party for the rest of their lives (see, for example, who voted for Reagan in the early 80s ), and the same dynamic is clearly at work in India, where the vast majority of young people support Narendra Modi's BJP. In addition, the heavy defeat of the Indian Congress Party more or less ends the political path of the Nehru-Gandhi dynasty and the resulting internal struggle for control (and the possible resurgence of corruption investigations) will render the party virtually inactive for a while. ' of time. The end result is similar to the "one-and-a-half system" that helped the Asian tigers (Korea, Taiwan, and Singapore) maintain a policy stance during their peak growth years. For this reason, we are more optimistic than the general consensus on the chances that the BJP can carry out a reform plan against the opposition government or the Rajya Sabha (the upper house of Parliament).
2) Modi has very clear goals in mind and the markets will put pressure on him to put them into practice. The major weakness of the Indian economy has been the bottleneck on the supply side, in addition to the country's macroeconomic problems, which have impeded productivity growth. Fortunately there is a strong consensus on possible solutions and the persistent economic vulnerability could push Modi to remain focused on reforms rather than being distracted by nationalist dynamics. After all, with India's sovereign credit rating hovering above junk, the scope for political complacency is slim. For this, we expect a strong advance of the reform process, such as the Goods and Services Tax (GST), the reform of rural employment guarantees, the approval of infrastructure projects and fiscal consolidation, and in a period faster than the markets expect. It also helps that some key measures have already been defined by the outgoing government (unique identification, multi-brand FDI) and are just waiting for their effective implementation.
3) The Modi-Rajan combination is well positioned to gain favor in the financial markets. Raghuram Rajan, the Governor of the Reserve Bank of India (RBI), already enjoys the respect of international markets thanks to his efficient leadership of monetary policy during last year's sensitive phase of tapering. Rajan is committed to keeping the RBI on a clear inflation target and we believe that the new government, with its commitment to fighting structural inflation (on behalf of its urban middle-class supporters), will contribute to those efforts . And the market is poised for a multi-year uptrend, both on the equity and bond side, that would be reminiscent of the Reagan-Volcker period in the US during the 80s.
4) Looking ahead, India's balance of payments will benefit from the convergence of several favorable medium-term factors. India is certainly one of the last remaining bastions of young workers in Asia and real supply reform will improve the country's external balance by making capital flows (especially FDI and equities) more stable. Furthermore, the RBI transition will boost the opening of the debt market to foreign investors as Chinese and Japanese are encouraged to invest overseas. A recent IMF study reveals that the diversification of China's bond portfolios, in the event of an opening of the country's capital, would result in a flow of between 7-23% of debt into emerging markets. If India does so too, it could benefit disproportionately given current interest rates. Given all of this, we believe India is a compelling bet for long-term investors. The clear election outcome, which substantially reduced political uncertainty, is likely to boost growth and investment. The road to economic recovery will certainly be bumpy due to the countless challenges that still remain within the economic fabric. However, we are confident that India will be able to capitalize on its enormous potential and lend further support to the economic transformation of South Asia.
