Modi government and stock market: What lies ahead?

During the last four years of Modi government, the entire market cap of all Bombay Stock Exchange (BSE) went up by whopping 73% to Rs.145 lakh crore now from Rs.84 lakh crore as of May 2014. This is phenomenal considering the fact that the base of domestic market cap grew exponentially in this millennium – from a meagre around Rs.6 lakh crore in 2000 to over Rs.84 lakh crore in May 2014, a rise of over 14 folds! 

Bold initiatives on economic reform front by the Modi government seem to have helped the capital markets to rise by such phenomenal levels by re-rating of overall market valuations. This bull phase in the market was not accompanied by any robust liquidity infusion from the FIIs, nor supported by strong earnings growth. While the previous UPA government period, the domestic equity markets attracted over Rs.4.80 lakh crore from the FIIs cumulatively, the same so far in this present government regime is around Rs.1.69 lakh crore, which is about 38% of what our markets received during the previous UPA regime (FY2010 to FY2014). 

Though demonetisation failed to deliver desired results, the courage with which the Modi government took up this initiative and followed it up with GST implementation gave a lot of confidence to the investors. The government successfully managed to implement path-breaking reform viz GST without having required majority in the Rajya Sabha. Before GST, it also executed reform measures of liberal FDI (foreign direct investment) into the insurance and aviation sectors.

However, these reform measures failed to attract substantial FII flows into equity in the first four years of Modi government, the FDI inflows were about 42% more than what the country received during the previous five-year period. But the FII flows into equity were not robust as there was no strong earnings growth visibility in the large-cap space, which was first impacted by rise of significant signs of deflationary pressures worldwide and later by certain structural developments in the domestic economy. Signs of deflationary pressures peaked during January – February 2016 which was evident from crude oil price hitting 12-year low, some of metal and resources prices touching around 6-year low and surprisingly even global food price index also touched about 6-year low.

Structural issues have led to a “single digit growth syndrome” in many sectors.  IT sector revenues (due to large base effect, visa issues from the US), pharmaceutical exports (aggressive quality practices of the US FDA), sales volume of cement and real estate (elevated real estate prices), bank lending & private sector investments (inherited NPAs, risk aversion to lending, which saw decades low growth rate), telecom revenues (penetration of mobile peaked, realization crashed due to fierce competitive battle), etc. suffered from poor single digit growth. Unfortunately, most of the large cap companies are widely present in these broad sectors and hence, many of them faced poor visibility on earning growth. Perhaps for this reason, inflows into the equities by the FIIs – which primarily focus on large caps - were not robust. 

Many small and mid-cap stocks, which operate in micro and diversified businesses, also the ones benefited by cheap oil (tyre, paints, chemicals, etc.) rallied substantially, supported by the retail investors. This is partly evident from the fact that while the Sensex (a benchmark of large cap stocks) rallied about 43%, the overall market cap of BSE stocks (including over 4,000 small and mid-cap stocks) zoomed 87% during the period May 2014 to January 2018. FIIs historically have very low penetration in the Indian mid-cap space.      

Going forward, the equity market will be volatile with downward bias till two more major state elections are completed in December 2018. If the Modi government comes back to power in 2019, the positive sentiment, especially from the retail investors, would continue and the market would scale a new high. If the Modi government fails to return in 2019, the market would have a significant knee-jerk reaction to the markets with substantial downward bias. 

That said, long-term investors need not worry – the markets have rallied 88% during the previous UPA regime also despite the ruling party lacking majority on its own. The Sensex hit a fresh record high of 21,000 in 2008 despite the collusion government at the Centre. This leads us to believe that what matters to the equity investors, including FIIs, is success of democracy, effective economic reform measures and strong corporate earning visibility. 

The Modi government has done well on economic reform measures, managed to stick to fiscal deficit targets (significantly benefiting out of cheap oil), spurred capital expenditures by the government-owned enterprises and attracted strong FDI inflow. The market has also liked it and the equity investors were rewarded. Drawing a lesson from these facts, the new government will also be forced to continue with such initiatives. There is no option.  
 

Disclaimer: The author is founder and managing director at Equinomics Research. Views expressed are his own.