IndiaJun 24 2019

Modi’s landslide victory is no panacea for India’s stock market

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Modi’s landslide victory is no panacea for India’s stock market

Investing in India based on consensus expectations and without critically examining all the facts is fraught with considerable risks.

Current stock market valuations are near historic highs, buoyed by the return to power of a stable and business-friendly government, led by Prime Minister Narendra Modi (pictured), amid high foreign portfolio inflows year to date.

The stock market is not necessarily wise and it has been proven wrong several times in the past, especially when there is a clear disconnect between fundamentals and expectations.

The most recently released earnings results have been disappointing, to say the least, across sectors.

High GDP growth data has also somehow failed to translate into corporate earnings growth. In fact, this has been the case ever since India changed its methodology of calculating economic growth in 2015.

The next assumption that should be questioned is whether a stable and strong government has necessarily been right for India.

The dislocations caused by demonetisation and implementation of its goods and services tax have manifested in weak earnings but not in weak GDP growth.

What accounts for this?

A recent government report suggests that 39 per cent of the companies included in a database used to estimate India's economic activity were closed, untraceable or misclassified.

This does not mean that the GDP data is entirely wrong, as the larger companies, which account for the majority of the calculations, must have been counted appropriately.

This does, however, raise serious doubts over the integrity of the underlying data.

The government's delay in releasing unemployment data over the past five years has only added to the mystery.

An employment survey report that was leaked to the press after the government withheld its release also suggests that India's state of unemployment is at a record 45-year high.

So, any thoughtful investor should question whether the stock market exuberance is sustainable when India is undergoing so much economic pain.

The next assumption that should be questioned is whether a stable and strong government has necessarily been right for India.

Examples of the strongest governments have been situations in which a single party commands majority, either a simple majority at more than 50 per cent, or absolute majority with two-thirds command in the lower house of the parliament.

India enjoyed such governments for almost four decades following its independence in 1947, during which India's economic growth rates were lowest and it fought multiple wars with its neighbours.

In theory, an all-powerful single-party government should provide stability and execution speed.

But in practice, it works well only if there is internal democracy within the party and if there is enough room for debate and dissent.

Unfortunately this is not the case in India and most parties are very hierarchical inside, and revolve around personalities.

The most reforms India has ever enacted were when the country was run by a coalition government in the early 1990s.

The pace of reforms under a coalition government may sometimes be slow but this type of government is most likely to avoid making decisions that are too narrow in scope or too drastic in impact.

It is also more likely to respect dissent and consult with various stakeholders. 

As long-term investors, we focus on what is truly important, which is finding well-governed businesses that can grow sustainably in a profitable manner, and which are available at reasonable prices.

We try to avoid the noise that includes forecasts around the outcome of unpredictable events such as elections. 

A strong government might be good for the markets in the short run, but in the long run, transparency and accountability — better-nurtured in a coalition environment — appear better able to preserve India's democratic traditions and avoid drastic mis-steps that could send its economy backward.

Sunil Asnani is a portfolio manager at Matthews Asia