Might India’s elections rock local equity markets?

Please note: This article is more technical in nature than our typical articles, and may require some background knowledge and experience in investing to understand the themes that we explore below.

All data referenced in this article are sourced from Refinitiv Datastream unless otherwise stated, and are accurate at the time of publishing.

Key points

• The Indian economy has maintained its upward trajectory in the first quarter, following its performance as a leader among major economies last year. However, potential short-term challenges include the upcoming monsoon season and the April-May general elections – although the long-term outlook remains positive 
• Domestic equity markets are anticipating the current government’s re-election, while government reforms and strong company earnings are supporting stock valuations. These valuations may also appear high compared to international markets, but they are close to their long-term historical domestic average
• Unlike the US and Europe, India is unlikely to cut interest rates this year. Cash is currently generating attractive returns, and the 3-5 year segment of the domestic bond market is showing strong performance
• Increased market volatility is a possibility in the coming months – whether from election outcomes, central bank actions or geopolitical surprises. Diversifying portfolios to include private markets can be a strategy to manage these potential risks

India might be the strongest growing leading economy for now, but external factors could throw it off course. For now, heightened geopolitical tensions and considerable global economic uncertainties, not least on when the US Federal Reserve (Fed) could cut interest rates, are the main headwinds. 

However, with inflation now under control in developed markets, the Fed’s March policy stance was more dovish than some expected. The central bank’s ‘dot plot’ projections point to perhaps three cuts in 2024, though these are not official Fed forecasts. 

Strong investment activity underpins growth

India’s gross domestic product expansion of 7.7% last year topped other top-ten economies and continues to purr along at a similar momentum in 2024. 

Growth has been driven largely by fixed-capital formation, indicative of much investment activity, which points to a continuation of India’s recent momentum. More broad-based investment is likely needed for a boost. In this respect, a gradual uptrend in private sector capital expenditure (capex) is warranted. 

The current account deficit is expected to remain stable this year, led by strong services exports and benign global commodity prices. Furthermore, steady domestic currency levels and improving forex reserves augur well for a stable external account. 

On the flipside, the government's final consumption spending has moderated, as has its growth in the private sector. This could prolong the recovery of demand in, already muted, rural consumption. Focus on fiscal consolidation could further weigh on growth in capex spending by the government. 

Possible near-term risks include an adverse monsoon season that may affect the inflation trajectory and market volatility triggered by elections. Globally, disruptions to shipping in the Red Sea are hitting supply chains. 

Investors’ attention focused on general elections

For now, the markets are building in another victory for the incumbent Indian administration in April and May’s general elections. However, there is more uncertainty over how big the winner’s majority will be. 

Once the elections are over (results are due to be announced on 4 June), investors’ focus will likely turn to the next budget (in June or July) and on the direction of travel for fiscal discipline and quality capex. 

Expect increased volatility in equities 

We retain an equal preference for large and other-sized companies. That said, mid- and small-capped stocks might witness higher volatility relative to larger businesses, however the risk/reward appears favourable for this segment over the  long term. 

In the near term, markets will continue to be focused on election outcomes and earnings for fiscal year 2024. While equity valuations are better than those for global markets, they are only slightly higher when compared to their long-term average. In addition, political stability, consistent reforms, strong earnings growth, and more inflows into domestic securities bode well.

The domestic cyclical growth theme seems a particularly strong driver of potential performance. Sectors like power, manufacturing, infrastructure, capital goods and select consumer discretionary segments appear especially well placed. 

Fixed income turn neutral on duration, fall in yields remain limited

Indian bond markets have been calmer than their peers this year. Strong demand from local and foreign investors has supported rates, even though US rates have edged up by 30 basis points in 2024.

While monetary policy is unlikely to be relaxed in India as well, the rate-cutting cycle will probably be gradual as growth continues to be buoyant. Additionally, lower gross borrowing announced in the interim budget, as well as overseas buying, on the back of the country’s inclusion in JP Morgan and Bloomberg emerging market bond indices, and strategic allocations should buoy demand for domestic government bonds.

Cash (up to 12-month papers) offers accrual yields of around 7.5%. The scope for yields to drop further limits the upside from a capital gains perspective, until the trajectory for rates is clear.

With healthy spreads, the 3-5 year segment of the market appears well placed from an accrual perspective. Additionally, AA and A-rated credit offers better yields still from a risk-reward perspective, considering the lower credit risk in light of issuers’ stronger balance sheets. 

Elsewhere

Private markets tend to perform well when economies are humming, as seen in India, and can play a role in portfolio diversification and potentially improve risk-adjusted returns, both across private credit and private equity. One area in this segment of the market is warehousing, given the strong demand and limited investment options available in local public markets. 

With US inflation expected to head to target in the coming year, real interest rates are likely to dive lower while gold prices could head higher. In addition, expectations of rate cuts should weigh on the US dollar, with strong central bank demand positive for the gold price, due to heightened geopolitical uncertainty.  

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