Vijay Kumar Gaba

Verdict 2024: Market Implications

An analysis of the past 30 years of market trends provides no evidence to suggest that elections, the form of government, or the strength of a particular party in the parliament impacts the market performance significantly. However, it is common to see higher volatility during or around elections.

Insofar as the fear of a multi-party coalition or a fractured mandate is concerned, I believe, the investors should be relieved by the prospects of a true coalition coming to power. Because, in the post-independence era, the best periods for the Indian economy have been those when a “coalition” government was in power.

It is however important to note that by “coalition” I do not mean just a multi-party government. In my view, coalition government means where people with diverging socio-economic policies jointly participate in a government. Empirical evidence suggests that such coalition governments in India have agreed on a common minimum agenda and focused on executing the same, avoiding conflicts and logjams.

The first cabinet of India post-independence had R. K. Shanmukham Shetty (Finance), Shyama Prasad Mukherjee (Industries) B. R. Ambedkar (Law) and Jagjiwan Ram (Labor). These people did not subscribe to the Nehruvian socio-economic agenda, but we got a robust socio-economic framework. The singular governments of Nehru (post BRA, RML, SPM - 1956 and 1961), Indira Gandhi (1971, 1980), Rajiv Gandhi (1984) are not known for good governance or transformative socio-economic reforms.

Morarji Desai (1977 – FERA dilution, Gandhian socialism), V. P. Singh (1989 – tax reforms, social justice), Chandershekhar (1990 – disinvestment, fiscal reforms), PV Narsingh Rao (1991 - liberalization, delicensing), Devegoda/IK Gujaral (1996 – dream budget), Vajpayee (1998, 1999 – divestment, infra development) and Manmohan Singh (2004 – RTI, RTE, UIDAI, Right to Food, Right to Healthcare, MNREGA, Civil Nuclear Deal, FDI in retail & pension etc.) were all coalition governments. These governments are all remembered for socio-economic reforms causing fundamental changes in the socio-economic milieu of the country. None of these governments is remembered for non-governance, anti-market policies or anti-business stance.

The incumbent government has taken three major initiatives in the past 10 years, that have helped Indian equity markets:

(a)   Abolition of 86% of currency notes in circulation in November 2016. This measure is popularly believed to have benefitted the large organized sector businesses (mostly listed) at the cost of smaller and marginal businesses (mostly unlisted).

(b)   Implementation of GST from July 2017. This is also popularly believed to have enhanced the competitiveness of large businesses (mostly listed) at the cost of smaller unorganized and non-compliant businesses.

(c)    Promoting local manufacturing through production-linked incentive (PLI) schemes for a variety of sectors.

However, the gains from these initiatives have not been true to the expectations due to the unpredictability that crept into the policy framework and sub-optimal execution.

Thus, in my view, the policy risks in India from the political side are low and not to be much bothered about. The key risk is execution and this risk has little to do with the form and constitution of the government of the day.

Insofar as the market performance during coalition or minority governments is concerned, there is no evidence that markets have performed poorly due to the form or constitution of government.

2024: Market after elections

Regardless of election results, the markets may remain volatile and directionless until a government is formed.

Bonds: The bond market will be guided by the full budget for FY25 that may be presented in the last week of July 2024. A significant violation of fiscal discipline, and disappointment in the inclusion of Indian bonds in global indices may lead to a sell-off. Else, we may see a stable bond market. A good monsoon, as forecasted by IMD and other agencies, may brighten the outlook on inflation, and a softer RBI monetary policy stance.

Equity: The corporate earnings for 4QFY24 have been below the consensus estimates. This has resulted in downgrades in FY25 and FY26 earnings forecasts. If the trend continues in 1QFY25, we may see further earnings downgrades and de-rating of the market in general.

A BJP victory, as widely expected, may extend the rally till mid-July. After that, the market direction would be determined by the budget proposals and earnings outlook.

In a less likely situation of an INDIA government, we may see a knee-jerk move downward that may get reversed in the next few weeks. After that, the market direction would be determined by budget proposals and earnings outlook. In this case, however, we may see a material sectoral rotation towards consumption, given the INDIA promise to afford significant cash in the hands of consumers.

In any case, the impact of election results may not last beyond July 2024. The strategy should therefore be to actively look for opportunities (to buy or sell) in case of any material rise or fall in prices on or after 4^th June.

Also read

What if? – Part 1

What if? – Part 2

In the past two months, many readers have asked about my expectations of the outcome of the ongoing general elections and the likely impact of it on the Indian economy and financial markets. I am glad to offer my opinion, with the rider that I am an independent observer of Indian politics and have no affiliation or inclination towards any particular political party or group thereof.

Economic impact

I believe that in India economic policies, and therefore financial markets, are politics agnostic. I do not see the outcome of general elections impacting the Indian economy in any significant manner.

A study of the history of Indian politics would suggest that, unlike the Western democracies, only an abysmal minority of Indian voters are strongly committed to a political or socio-economic ideology. Contemporary issues, personalities, and election promises usually dominate the political discourse in India. Economic issues raised during elections are mostly confined to the slogan of poverty alleviation and handouts to the voters. Unfortunately, no political party has taken the issue of poverty alleviation seriously. Therefore, no one has bothered even to outline a conceptual or ideological framework for solving this problem.

Ideologically, in the early days, the Congress Party abandoned the most acceptable and perhaps most suitable Gandhian Socialism in favor of Nehruvian Socialism - a poorly mixed concoction of Leninist central planning (central ownership and management of resources and businesses) and British colonial legacy (discretionary patronage to the faithful and loyal). The model was certainly at cross-purpose with the constitutional federal structure. Poverty, poor governance, and corruption were natural off-springs of this system.

BJP started with Deen Dayal Updhaya's Integral Humanism. However, in the 1990s it briefly adopted Gandhian Socialism (which is not too far moved from Integral Humanism) as the principal doctrine. The present leadership has, however, mostly followed a poorly mixed concoction of Leninist socialism and the Laissez-faire model used by some developed economies principally the USA.

Politically leadership preaches "Human Being" as the fulcrum of policy making. Whereas the executive is more focused on "Business" and "Macroeconomics" as the central theme. The conflict is for everyone to see. The consequence is slower and inequitable growth.

Until the mid-1980s, the people at the left end of the spectrum exercised significant sway at the bottom of the pyramid in Indian society since independence. They controlled most of the labor unions. Though divided between Marx, Lenin, and Mao they still were the preferred choice of landless, oppressed, and intelligentsia. There was a time when being poor, intelligent (economist, thinker, poet), or rebellious meant being communist.

Things however began to change in the late 1980s, after dismantling of the USSR and the German wall. The Lenin and Marx were relegated to the history lessons. The economic reforms initiated by Deng Xiaoping in China further pushed back the traditional Marxists.

Insofar as the socialist parties occupying the left of the center space in Indian politics are concerned, they deserted both Lohia and his ideologue Gandhi as soon as they came into power. Degenerated into motley feudal, they show little commitment or preference to any specific economic idea.

As I have been reiterating rather frequently, that the governments in the past 40 years have mostly adopted similar socio-economic policies consistently irrespective of their form or constitution.

The Ctrl C + Ctrl V has been the most preferred practice in the formulation of most government policies and programs, with some semantic changes to give it a different hue.

For example, consider the following:

1.    The process of meaningful tax reforms was started by the then finance minister V. P. Singh (Congress 1984-89) by rationalizing the tax slabs, lowering maximum marginal tax rates substantially, rationalizing wealth tax and introducing CENVAT. The recommendations of Raja J. Chelliah Committee (1991-93) on tax reforms constituted by the government (Congress 1991-96) have since formed the basis of tax reforms in India. All successive governments have implemented these recommendations. No government has sought to reverse or alter the process started by the Congress government (1984-89). These recommendations formed the core of the much awaited Direct Tax Code. The origin of the tax proposal like lower tax rate with lesser exemptions and no wealth tax could also be traced to that.

Committees formed under the chairmanship of other members of the Raja Chelliah Committee like Govinda Rao, Partha Shome and Vijay Kelkar, etc. subsequently updated the recommendations to provide further impetus to the entire process of tax reforms in the country.

It was the Finance Minister of H. D. Devegoda led United Front government who presented the most talked about "dream budget".

2.    The recommendations of the Narsimhan Committee (1991-92) appointed by Dr. Manmohan Singh, the then finance minister in the Congress government, have largely formed the basis of financial and banking sector reforms in the country. Most successive governments have implemented the recommendations consistently. P. Chidambram, the then finance minister in the United Front government (1998) had re-appointed the Narsimham Committee to make recommendations about the second-generation banking sector reforms. The report was submitted in 1999 to the NDA government which accepted the recommendations. However, almost all governments have failed to build a wider consensus on these recommendations and have only partially implemented them. But acceptance and rejection have been very consistent irrespective of the form and constitution of govt.

3.    The BJP led NDA government enacted the Fiscal Responsibility and Budget Management Act (FRBMA) in 2003. The arch-rival Congress led UPA-I government implemented the same in 2004 in letter and spirit. This still forms the basis of fiscal discipline at central and state levels, though implementation was suspended in 2009 in the wake of the global crisis and again in 2020 due to COVID-19 stimulus. The incumbent govt. has committed to achieving the targets in the next two years.

4.    The minority government of Chandrashekhar introduced a disinvestment policy in 1991. Every successive government since then has accepted the policy in principle. They have tried to incorporate disinvestment policy into the evolving economic model. However, they have consistently failed to implement the policy in the right spirit. None has achieved the disinvestment targets set in the respective budgets.

Prime Minister A. B. Vajpayee took it further by divesting many government monopolies like coal, power, roads, ports, airports, telecommunication, insurance, etc. Subsequent governments added to it by allowing private players in sectors like pension, defense production, etc. No government has sought to reverse the decisions of the earlier governments.

5.    A single national market (GST), as a desirable idea, was conceived long ago. Many governments deliberated and developed the idea. The incumbent government finally implemented it in 2017, when the infrastructure and logistics considered necessary for rolling out GST reached a reasonable stage.

6.    Programs such as cleaning the holy rivers of Ganga & Yamuna and provision of toilets in every home have been accorded priority by all successive governments.

7.    One of the key areas of corruption in public life has been the executive's right to allocate natural resources for commercial exploitation. The Supreme Court effectively curbed that right in its judgment in the allotment of 2G spectrum case.

An auction-based transparent regime is the outcome of the court-directed process, which is mostly irreversible and therefore party agnostic.

8.    The UPA government created enabling infrastructure for the digitalization of the economy through UIDAI, NPCI, etc. The subsequent NDA governments used this enabling infrastructure for the massive development of the digital transaction ecosystem.

9.    The NDA-1 government started the ambitious National High Development Program (NHDP) in 1998. The UPA government removed the obstacles in the implementation of this program through a remunerative and widely acceptable compensation and execution policy. The NDA-2 used it for accelerated construction of roads and highways, without seeking to change anything in UPA policy.

10.  The UPA government started a new practice of lateral appointment of professionals by appointing Nandan Nilekani to head UIDAI. The later governments continued with this practice and appointed many professionals to head the NITI Aayog.

From the above-cited example, it is evident that the direction of policy-making has been mostly the same on most accounts during the past three decades. The difference lies in the execution.

It is pertinent to note that the governments led by P. V. Narasimha Rao’s and Atal Bihari Vajpayee made many historic departures from the past and took many new policy initiatives.

The end of the Nehru era's license, quota & permit raj, abolition of capital controls and introduction of LERMS, entry of private players in civil aviation, opening of the financial sector, etc. were some major path-breaking reforms introduced by P. V. Narasimha Rao government.

Divestment of major government monopolies like power, roads, wireless communication, ports, airports, insurance & hydrocarbons, focus on rural connectivity, deregulation of fuel pricing, and liberal FDI regime, etc., were the key new policy initiatives during the Vajpayee led NDA regime.

The 10 years of the UPA regime introduced a new paradigm in the Indian socio-economic milieu, viz., the Right-based Socio-Economic regime. Right to Work, Right to Food, Right to Education, Right to Information, Right to Health, etc. some of the ideas propagated in their regime.

Implementation of right-based entitlement has been patchy and questionable, but no one has so far challenged the approach. The incumbent government has sought to partly implement the Right to Health that was promised by UPA in the last few weeks of its regime, through a universal health insurance scheme in the union budget for FY19. The current government has also enhanced the Right to Food program.

The UPA government signed a civil nuclear deal with the US. This started a new era of India’s strategic partnerships with developed countries like the US, France, Germany, Japan, and Australia, etc. The incumbent NDA government has taken this further through multiple bilateral agreements for Free Trade and movement of capital and labor with many of these countries.

The change that we have seen in the past ten years of the incumbent government's regime is the dominance of market economists (against development & social economists before) in the consultative bodies of the incumbent government. This change in my view is the outcome of the change in the global positioning of the Indian economy and markets. There is nothing to suggest that a change in the government at the center would materially change this position in the near-term, unless international developments completely change the global balance of power and global market paradigm.

In short, the economic policy of India is still a work in progress. all governments in India in the past 40 years have made incremental improvements in the policy framework to make it congruent with the scale of economic development and changes in India's position in the global economic and strategic order.

…to continue tomorrow

Also read

What if? Part 1

Since the Election Commission of India (ECI) does not permit the publication or communication of the results in any other form of Exit Polls conducted by various agencies until the completion of voting for all seats, we do not have any expert opinion available about the likely outcome of the ongoing elections. However, a variety of guesstimates are available on social media and other platforms. Most of these guesstimates are speculative. These are either based on a small and localized sample; or gambling trends.

Many stock market experts have also presented their scenario analysis for the market performance depending upon the outcome of the general elections. Most experts have projected a sharp correction in the markets in case the incumbent BJP and its allies fail to secure the requisite majority in the Lok Sabha. As a keen political observer and a tiny investor, I am interested in these forecasts.

Unfortunately, I find that the discussions available in the public domain are not based on available empirical evidence; they lack credible analysis, and are highly speculative. These discussions deeply suffer from personal biases, political prejudices, and misplaced presumptions. One of the illustrative scenario analyses available in the public domain is reproduced below. In my view, nothing could be more baseless and more speculative than this analysis.

In the outgoing 17^th Lok Sabha, the incumbent BJP has 303 members, a strong majority. In the preceding 16^th Lok Sabha, the BJP had 281 members with its NDA allies having another 71 seats.

The preceding UPA government was arguably much weaker with no single party having a majority of its own. Regardless, the performance of USDINR and Nifty was better during 2004-2014 compared to the 2014-2024 period.

·         Sensex yielded a return of 15.5% CAGR during the UPA regime (2004-2014), while the Sensex return has been ~12.2% CAGR during the NDA regime (2014-2024).

·        USDINR had weakened at a pace of 2.7% CAGR during 2004-2014; while it has weakened at a pace of 3.5% CAGR during 2014-2024. 

On the social and economic reforms front also there is no empirical evidence of weaker governments doing worse than the stronger governments in the past four decades.

In my view, the market does witness heightened volatility during general elections, but there is no empirical evidence to establish a direct correlation between market performance and the form and constitution of the ruling political dispensation in India.

…to continue tomorrow

·         Nifty Next 50 Index (YTD higher by ~21%), which comprises the top 50 stocks outside the Nifty50 (YTD higher by ~2.7%) universe, has performed much better than the Nifty Midcap100 (YTD higher by ~9%) and Nifty Smallcap 100 (YTD higher by ~10%) indices.

·         If we exclude private banks and IT services stocks from the Nifty50 universe, the rest of it has performed better than the broader market indices.

·         These statistics (index performance) completely fail to present a correct picture of the market. The narrative that small caps have done better than large caps is mostly false. On a risk-adjusted basis, large-cap stocks may have done far better than their smaller peers.

·        Even in developed markets like the US, a few large-cap stocks have done extremely well and broader markets have underperformed sharply. The discount of small-cap valuation vs the large-cap valuation in the US markets is the highest since the dotcom burst in 2001.

In my view, all these are fair points. However, my premise behind “no margin for error” was entirely different. I wanted to communicate that –

(a)   Presently, the small investors appear edgy to me. They have invested assuming a clear blue-sky scenario. Any sign of the dark clouds on the horizon would make them jittery and they might look to exit their positions.

Empirical evidence indicates that these small investors prefer to invest in smaller businesses where the chances of making big returns are significant. Besides, these investors have very low risk appetite. If the market witnesses a sharp fall, due to whatever reason, they may seek to exit their position. However, given that the liquidity dries very fast in the broader market their exits could come at a significant impact cost. On a bad day, the exit cost could be 20-50% more than what they would have assumed in a normal market scenario.

(b)   A large section of these small market participants is indulging in option trading. The potential losses in the options segment could be substantially higher and permanent since the single stock options tend to become extremely illiquid in case of sharp moves in the underlying securities.

(c)   The standard investing arguments – invest for the long-term; ignore intermittent volatility; small-cap yield a much larger return than large cap over a longer term, etc. – are very much true. However, it cannot be denied that human psychology and the personal circumstances of individual investors override these arguments. The forces of fear and greed dominate the day to day investment and trading decisions of individual investors. If the basic assumptions behind an investment decision fail or the overall market sentiments turn negative, the fear overwhelms the investing decisions of investors with a low-risk appetite. This is where most of the losses occur.

My favorite fund manager highlighted “NVIDIA is more volatile these days than even SME segment. More people would have lost money trading in NVIDIA than the number of investors who would have made money holding it. Trading is for mental wellness, while investing is for material gains”.

I cannot disagree with this proposition. I think most people would agree with it, in principle. But then how many of us live the way our parents and teachers guided us to do!!!

The case of Last Friday is particularly noteworthy. The benchmark Nifty corrected almost 2% from the day’s high within a few minutes, ostensibly due to a media report suggesting implementation of the Direct Tax Code in the July 2024 final budget for FY25. The volatility index (India VIX) spiked over 33% to a multi-month high. The finance minister outrightly denied the report calling it “Pure speculation”.

In my view, three clear inferences could be drawn from this instance.

First, the market is bravely holding up, in line with the global trend. However, the risk appetite of investors and traders may be diminishing. The margin for error, should something go wrong, is very low. For example, if the financial performance of companies misses the elevated expectation levels; the outcome of general elections is contrary to popular expectation; and/or the monsoon is delayed or misses the “better than normal” forecast of the Indian Meteorological Department (IMD), the market may witness sharp corrections in the short term.

Second, the market participants have been very vocal in demanding material direct tax reforms for many years. The reactions to the market rumors of tax reform that may see higher tax rates indicate that the market’s idea of tax reform is nothing but lower tax rates and more exemptions (especially LTCG and dividend tax). There may be no appetite for a progressive tax structure that helps in an orderly wealth redistribution over a longer period without material impact on the revenue needed for the development effort.

Third, during the intraday sell-off, very large part of the market becomes extremely illiquid. The impact cost for selling in such a situation becomes very high. This is true, especially for the option traders. There have been many instances in the past two weeks where the hedges (stop loss) did not work; options became illiquid and even the hedged trades could not be squared; and small and midcap stocks hit lower circuits and could not be sold. If a larger correction begins in the market due to whatever reason, the losses to traders could be much more than usual.

For the record, YTD 2024 - Nifty50 is higher by ~3%; Bank Nifty is higher by ~1%; Nifty Midcap100 is up ~9.5%, Nifty Next 50 is higher by ~21% and Nifty Smallcap100 is higher by ~11%. Rationally speaking, the scope for correction is equal in the large cap and smallcap space that has seen sharp outperformance; and banking that has been weak even in good times. However, given the tendency of liquidity to dry fast on the first sign of correction, the potential losses (Value at Risk) are much higher in broader markets.

Gold prices hit an all-time level in April and have corrected marginally since then. Again, this is the time when self-proclaimed investment gurus commemorate Indian households, especially the women, who have traditionally parked their savings in gold ornaments. They highlight how the uneducated and unaware “mothers” have managed to earn more return than savvy investors who invested in index funds etc. In my view, this narrative is completely flawed and does not merit any comment.

The all-time high gold prices in international markets have also triggered a deluge of reports forecasting a strong performance of gold in the coming years. The key arguments in favor of a strong rally in gold prices are (i) technical breakout; (ii) central banks amassing gold reserves in anticipation of the diminishing role of USD in the global economy; and (iii) the Dilemma of the Bank of Japan whether to protect bond yields or Yen. The traders have however pointed out that the higher gold prices are currently supported by the strong investor demand from China. The gold imports, other than the central bank buying, into China, have surged sharply in recent months and so have the trading volumes of gold in China.

In my view, gold is a declining asset and as such should offer sub-optimal returns in the decades to come. Particularly, for investors in a fast-growing economy like India, investment in gold makes little sense for household investors. It may be a bad idea for Indian investors to emulate their Chinese peers and invest in gold. Those advising Indian investors to invest a material part of their wealth (10% or more) in gold, because gold prices are likely to move higher due to buying by central banks and Chinese consumers/investors must consider the following:

·         Chinese households are much richer and more protected as compared to Indian households. China’s per capita GDP (US$13136) is almost 5x of India’s per capita GDP (US$2731). Chinese households enjoy much more social security and a higher standard of basic amenities like education and health.

·         The Chinese economy (US$18trn) is 5.3x in size as compared to the Indian economy (US$3.4trn). It is expected to remain much larger than India for the next 50 years at least, despite slower growth.

·         China has forex reserves of US$3.23 trn as compared to India’s US$640bn. Though both countries have reserves close to 18% of their respective GDP, India runs a current account deficit of appx. US$100bn as compared to current account surplus of US$253bn for China. China needs to diversify from US and European treasuries and USD assets to protect its reserves from depreciating. For now gold is one of the popular option for it. India on the other hand does not have similar needs, given our current account deficit.

·         The per capita income in China has grown at a CAGR of 6.1% over the last decade. In this decade, Chinese equities have provided a CAGR of 3.5% and real residential prices have barely risen. Whereas Gold in CNY terms has yielded a CAGR of 7.75%. However, for Indian investors, per capita income has grown at a CAGR of 5.3%, real property prices have grown 1.1% and equities have yielded a return of 11.4 CAGR. Chinese investors therefore have reasons to buy a hedge against inflation and negative real rates. The Indian investors on the other hand have little reason to diversify from high-yielding equities and positive real rate offering debt. Besides, they need to invest heavily in their education and health, unlike their Chinese peers.