Last week when I met with the head of equities at one of India's largest private insurance companies, he said that in his 16-year career the last three years were the worst for the country. "And my worry is if [Bharatiya Janata Party's Narendra] Modi doesn't come to power than another three will continue to be bad for India."
His major fear was if Modi doesn't come to power the stock market will see a free fall. Most importantly, the rupee will fall close to 70 per dollar following an outflow from foreign institutional investors. If that happens, it will have a contagion effect with the greatest fears for India being a downgrade by rating agencies. India is just one notch above the junk status. A downgrade would mean losing its investment-grade rating and no money coming into the liquidity driven equity market. FII flows remain key to India and its capital markets. Rating agency Moody's has clearly indicated it would downgrade India if it doesn't see a stable government at the centre. A fragmented government without either a clear mandate or policy platform would heighten the downside credit risk.
In the current scenario, however, the fear seems to be unwarranted and a downgrade doesn't look likely. Looking at the economic numbers one would feel the fear of a downgrade has receded with the current account deficit and fiscal deficit under control and the rupee stable. This along with export income improving, import declining as well as inflation falling to an eight-month low augurs well for India. On the currency front, the Reserve Bank of India (RBI) has done a remarkable job with strong foreign exchange reserves ($292 billion) as well as allowing domestic banks to raise foreign currency non-resident deposits up to $30 billion. The RBI is also keeping a close watch on the US by keeping favourable interest rate differential among both nations such that flows into India remain intact. The new Fed chief's statement that interest rates will not be raised in the medium term has brought comfort to the market.
Today, barring a stable government at the centre all factors that could pull down the market - increase in US interest rates, uncontrolled deficit and drop in FII inflows -- have taken a back seat.
So, why is Modi important for the market? There is a feeling that the National Democratic Alliance (NDA) is pro-business, and therefore everyone wants Modi to come to power as they think he will replicate the Gujarat growth model in the country. This is the reason why most companies have stalled their investment spends as they don't have the confidence in the current system.
One wonders why it took 10 years for businessmen to realise that the NDA is pro-business. You can call it luck that played a huge role in the United Progressive Alliance (UPA) governing India for the past 10 years. After the UPA came to power in 2004, India saw its biggest ever bull-run for the next five years and it also enjoyed the multiplier effect of work that the previous government had done in terms of infrastructure and growth. In fact, in May 2009 after the UPA emerged victorious, the Sensex rose 20 per cent in a single day on the hope that reforms will take forefront, but the UPA's second stint was marred by corruption and scams, and reforms and growth took a back seat.
Today, the government machinery is in a deadlock. The market wants a government that is pro-reforms. It is not that Modi has a magic wand that can bring growth from day one. It will take at least 12 to 18 months for the economy to come back on track, but hopes are if Modi comes to power he will start on a clean slate and will have no baggage like the UPA, which will help him to drive economic reform and growth. Though the market is hoping for Modi to come into power, Modi or not, a stable government at the centre will emerge as a key catalyst for the market.
Meanwhile, with the December quarterly results coming to an end, the focus will shift to global markets and FII flows. On Monday, the government will also unveil its interim budget for 2014/15. In less than 100 days India will see a new government coming into power. Until then, the Indian market may remain rangebound as well as volatile, and react to global events.