Opinion
Indian stock performance is not dependent on electoral results
Summary
The long-term record shows that equity returns and economic reforms are correlated but neither are hurt by political shiftsOn 17 May 2004, Indian stock markets hit their -20% lower circuit. The Bombay Stock Exchange’s Sensex fell by 842 points, then its steepest ever one-day fall. The National Democratic Alliance (NDA) led by the Bharatiya Janata Party ( BJP) had lost that year’s general election to the United Progressive Alliance (UPA) led by the Indian National Congress (INC). That the UPA was supported by communist parties seemed to have spooked the markets into believing that India’s economic reform momentum would end and growth would stall. I joined Quantum in August 2004 and my boss and its founder Ajit Dayal guided me to write my first research piece, a simple analysis to show that election results do not matter to long-term returns. India’s GDP growth and market returns are uncorrelated with the government in power, Indian corporates are used to this loud and messy democracy, and any market correction due to just a change in government is a buying opportunity.
Between 1980 and 2004, the central government changed seven times, with four of those run by coalitions. The average real GDP growth in that period had risen to 5.8%; the Sensex delivered compounded annual growth of 5.8% in dollar terms and 16.3% in rupee terms.
India’s reforms initiated in 1980 have continued under all governments, be it coalition or single party; be it tilted to the left or the right.
Let’s update that analysis. Between 1980 and 2023, the government has changed 11 times, eight of those were coalitions, though both governments since 2014 have had the BJP with clear majority of its own (and effectively been single-party administrations), average real GDP growth since 1980 has risen to 6.2%, and the Sensex has delivered compound annual growth of 9.5% in dollar terms from 1980 to August 2023 and 15.5% in rupee terms.
If stock markets correct only because of a change in government in 2024, you know what to do.
While general elections are several months away, what has got the market talking about them is a joint strategy of opposition parties to take on the two-term Narendra Modi government. Although the BJP is the only party since the INC in 1984 to have won two successive elections with a majority of its own, it seems rattled by the opposition calling its alliance ‘INDIA’ (Indian National Developmental and Inclusive Alliance). So much so that the government has started referring to the country as Bharat in official communique.
Varied probable outcomes have got sell-side strategists excited. Morgan Stanley and Jefferies have come out with long reports analysing possible scenarios and likely outcomes.
Jefferies assigns a 10% probability to a BJP defeat in 2024 and expects markets to correct by 10%. Morgan Stanley thinks markets would correct 20%-25% if INDIA wins and a 40% drop in a scenario of neither lead party getting 200 seats, leading to a weaker coalition at the Centre.
Long-term investors don’t need to worry, though. This is because successive governments will likely carry on the reform process and attract long-term capital, the government’s share of the economy isn’t very large—and is not only driven more by private enterprise but also linked more closely to the global economy than is apparent—and Indian corporates are well placed to deal with chaos in the political system. Since 1980, in general, India has pursued policies aimed at a more market-driven economy. It has deregulated, liberalized and privatised various segments of the economy, and facilitated the Rule of Law with institutions that let markets function, businesses survive and competition thrive.
Some governments may focus on hard aspects to facilitate the above, while others may choose to prioritize the softer reforms required to improve productivity. Some may be populist and others fiscally conservative. Some may operate by consensus, and others may take majoritarian decisions. But the broad direction will be pro-growth.
The BJP-led NDA has delivered some hard reforms, from building infrastructure and easing of foreign direct investment (FDI) to the adoption of inflation targeting and a bankruptcy law, while it has also delivered on softer goals with its household welfare measures, a thrust on financial inclusion thrust and digital transformation. However, it made a blunder with demonetization in November 2016 and its policies appear to have resulted in depressed farm and rural incomes.
The Congress-led UPA drove private investment in infrastructure, eased FDI and enabled rights-based reforms in food delivery, rural employment, access to information, education and identity verification (Aadhaar). But it also made a mess of managing macro stability and was riddled with corruption charges.
There is merit in a strong and stable government that can take firm decisions and implement them swiftly. But such administrations often lack parliamentary accountability. They can also take reckless decisions, like nationalization, the Emergency and demonetization.
What investors need is certainty. This comes from political stability. Since 1999, all governments, be it full-majority or coalition, have completed their full term of five years.
In a diverse country like India, coalition governance has the advantage of consensus-driven decisions. Some of India’s best reforms have happened under coalition governments. So it is not a constraint. But this aspect of democracy is also why India is not China and there is a limit to the economy’s potential pace of growth.
We believe that India’s long-term real GDP growth potential is 6.0%-6.5%. This implies annual nominal GDP growth of around 11%-12%. This nominal growth plus corporate productivity is what is reflected in equity markets and its indices.
Double-digit nominal returns have held good for the last three decades and will remain possible for the next two decades. The basic message for long-term investors, therefore, remains the same as it was in 2004. Buy India.
