Vijay Kumar Gaba

 Political state of affairs

The latest round of elections concluded with results of five state assemblies announced yesterday. BJP managed to retain their power in two states - Uttar Pradesh and Uttarakhand – with a comfortable majority, though the number of seats is lower than the outgoing assemblies. In two other states – Goa and Manipur - BJP is well placed to make a government. In Punjab, Aam Aadmi Party (AAP) has wiped out the traditional parties (SAD and Congress) in one of the major upsets.

Overall, the latest elections must be seen as continuation of some key political trends that started emerging in the past decade that saw emergence of BJP as a primary political party in the country and decimation of the Congress Party. BJP must be relieved after these elections that saw the entire central government, including the prime minister and home minister. Though less number of seats in Key states of UP and Punjab would mean that BJP leadership would have to remain busy till Presidential election in July are completed with a BJP candidate winning comfortably.

My key takeaways from the latest election are as follows:

·         AAP is well placed to replace Congress in national politics. In next 5years we may see AAP contesting to take Congress space in key states of Madhya Pradesh and Gujarat. That will make AAP a key national party.

·         The Modi-Yogi model of BJP means leaders’ direct connection with the electorate. Historically BJP has relied on the cadres of RSS and VHP for their election campaign. This may allow BJP to gradually move towards centrist politics from the right of the center agenda.

·         Caste is still relevant in Indian politics but the manifestation is changing. The electorates are associating caste considerations more with the candidates rather than the political parties.

·         Digitalization of governance has resulted in closer association of leadership (CM and PM) with the beneficiaries of the government schemes. This trend may continue to benefit the incumbents for next few years, before it is fully internalized by the voters as status quo. In this election free ration during the pandemic has done for BJP in 2022 what MNREGA did for Cong in 2009. But in 2024 it could be the case of Dil Maange More.

·         Women are becoming a major vote bank. This is a positive consequence of rising female literacy and gradually increasing female participation in the labour force. Presently this vote bank is favoring the ruling parties like BJP, TMC, AAP, DMK and JDU etc. But in future elections we shall see all parties specifically targeting this vote bank. The most positive impact of this would be the fading of caste and religion agenda and rise in inclusive politics.

·         UP has seen mushrooming of sub-regional parties. It is becoming a replica of national politics of the 1990s. In the latest elections it was BJP (with 3 sub-regional parties) on one side and 12 sub-regional parties on the other side. The results indicate that most of these sub-regional parties may survive and even BSP may become a sub-regional party. This trend may warrant the splitting of UP into multiple states in future.

·         Post this election, we may see a material increase in the intensity of efforts to form a Non-BJP, Non-Cong and Non-AAP alliance of regional parties.

Economy

The escalation of the war between Russia and Ukraine has material implications for the global economy. The global growth that was anyways slowing down after the effect of pandemic related fiscal stimulus subsided and central banks have started to withdraw monetary stimulus, has taken a noticeable hit. Sharp spike in commodity prices, especially food and energy, is hitting the policymakers as well as the common people.

The Indian economy is also witnessing slowing growth momentum for the past couple of quarters. Rise in global energy prices present a formidable challenge to the economy. If the current level of energy prices sustains for more than a month, the macroeconomic indicators like inflation, current account deficit, currency, and bond yields will all be impacted adversely, putting further pressure on growth.

As per the rating agency ICRA—

·         The current account deficit (CAD) is likely to widen by ~US$14-15 billion (0.4% of GDP) for every US$10/bbl rise in the average price of the Indian crude basket. If the price averages US$130/bbl in FY2023, then the CAD will widen to 3.2% of GDP, crossing 3% for the first time in a decade.

·         If the Centre reinstates the excise duty on MS and HSD to the pre-pandemic rates, before April 1, 2022, followed by the budgeted rise of Rs. 2/litre each on unblended fuel in H2 FY2023, we estimate the revenue loss to the Centre in FY2023 at Rs. 0.9 trillion.

·         In addition to the cut in excise duty, the GoI’s budgeted fiscal deficit would also come under pressure from high fertiliser subsidy requirements and a hit to direct tax collections due to elevated margin pressure for corporates. However, modest nominal GDP growth and tax buoyancy assumptions, and the spillover of the LIC IPO to FY2023 would provide some cushion.

·         Crude oil spike could exacerbate the impact of higher-than-expected FY2023 market borrowings of the GoI on yields. We expect 10-year G-sec yield to range between 7.0-7.4% in H1 FY2023.

·         Large downside risks seen to FY2023 GDP growth forecast of 8.0%, with higher commodity prices to compress margins during the duration of conflict.

As per Kotak Research, “As mentioned in our report Crude cost of someone else’s war, an average crude price of US$120/bbl in FY2023 will (1) cost the Indian economy US$70 bn, (2) increase average CPI by 80 bps and (3) negatively impact growth.

Edelweiss Research notes, “In the Indian context, the indirect economic impact of the conflict would far outweigh the direct fallout in terms of trade flows between India and Russia/Ukraine, which is low to begin with (around 1.5% for Russia and 0.6% for Ukraine). The impact would be felt in the real economy and financial markets alike. Furthermore, the uncertainty and erosion of consumer and business confidence that the crisis brings along could push back the anticipated revival in private investments.”

Emkay Securities highlights, “Higher oil prices can impact growth through multiple channels: 1) higher inflation erodes purchasing power, weighing on consumer demand; 2) lower corporate profit margins due to rising input costs; and 3) deterioration of the twin deficit, with government spending capacity being constrained. Crude at $100/barrel and other commodity shocks in FY23 could shave off up to 80bps of real GDP growth, which could end up below 7.0%.”

SBI Economics cautioned, “The recent geopolitical conflict has brought the focus back on government finances that might be derailed as the conflict intensifies. Against the possible impact on Government finances, the markets are already apprehensive of a larger borrowings. The Government has been quick to clarify that it is unlikely to borrow in March. Beyond this, the RBI does have a host of unconventional measures to manage Government borrowings in FY23 and it is important that debt market understands such nuanced undertows and does not get into a frenzy as it is swirling currently with crude prices threatening to move beyond $120.”

Markets

The markets are witnessing the beginning of an earnings downgrade cycle that may accelerate if the inflation stays elevated and rates firm up.

Kotak Securities highlights, “Market multiples appear ‘expensive’ relative to (1) history and (2) bond yields, despite sharp correction in recent weeks. However, ‘consumption’ stocks may see earnings downgrades from higher-than-assumed crude prices and lower volumes and gross margins. ‘Growth’ stocks are trading at expensive valuations and may see further downside to their multiples; financial stocks, however, are looking reasonably attractive.”

Credit Suisse has tactically downgraded Indian equities stating, “Because of its strong structural prospects and robust EPS momentum, we will look for opportunities to re-enter the market, but today we tactically cut our India position from Overweight to Underweight. Higher oil prices hurt the current account, add to inflationary pressures and increase sensitivity to Fed rate hikes. If Brent crude remained at US$120/bbl, India’s current account would weaken by almost 3 pp of GDP. The market’s big P/E premium magnifies the risks.”