The Reserve Bank of India meets Thursday and is widely expected to cut rates 25 bp. With Modi seen as likely to win a second term in the upcoming election, investors are likely to turn more positive on Indian assets.
General elections will be held from April 11 to May 19, with results likely to be announced May 23. The vote is spread out over seven stages due to the difficult logistics involving 1 mln polling stations servicing an estimated 900 mln eligible voters. 543 of the 545-seat lower house (Lok Sabha) will be contested, with the 2 remaining seats to be filled by nominees from the Anglo-Indian community.
Polls suggest the ruling BJP-led coalition will get the most seats but may fall short of an outright majority. Nahendra Modi is aiming to win a second term but may need to expand his coalition to do so. In the last elections, the ruling Bharatiya Janata Party (BJP)-led National Democratic Alliance (NDA) won 336 seats, with the BJP alone holding 282. State elections in 2017 and 2018 saw mixed results for the BJP, while several by-elections last year for the Lok Sabha went against the BJP.
The opposition Congress Party led by Rahul Gandhi has broadened its alliances. It has brought the Bahujan Samaj Party (BSP), the Samajwadi Party (SP), and the Trinamool Congress (TMC) into its United Progressive Alliance (UPA) coalition. Also, Rahul’s younger sister Priyanka has formerly entered politics. Back in January, she took a senior Congress post in the state of Uttar Pradesh. It was hoped that this would boost the standing of Congress, as Priyanka is widely regarded as being more charismatic than her older brother.
Prime Minister Modi has seen a bump up in his popularity. The most recent polls from March suggest the NDA will win somewhere between 264-285 seats, while the opposition UPA would win 125-138 seats. This is up significantly from January, when the NDA was seen winning between 225-252 seats and the UPA between 147-167 seats.
Tensions with Pakistan have eased. Cooler heads have prevailed after the February flare-up in Kashmir that saw a terrorist attack and several downed planes. Yet the situation continues to simmer. Just today, the two sides traded fire in Kashmir that left seven dead. We suspect India will work hard to prevent any more flare-ups ahead of the elections.
A BRIEF HISTORY LESSON
The Indian National Congress dominated Indian politics for decades after independence. India’s first Prime Minister after independence was Jawaharlal Nehru, who served for 17 consecutive years until his death in 1964. Former Home Minister Lal Bahadur Shastri became India’s second Prime Minister, but only served a little over a year and a half until he died of a heart attack in 1966. The dynasty continued, as Nehru’s daughter Indira Gandhi took the mantle of Prime Minister and served for the next eleven years.
In June 1975, a controversial state of emergency was imposed by Gandhi because India’s security was “threatened by internal disturbances.” Many consider this to be one of the darkest periods in post-independence India, as Gandhi jailed many political opponents and censored the press. Some religious organizations were banned, and many historians believe this was the closest that India ever got to becoming an autocratic state.
In response to growing protests, the state of emergency was lifted in March 1977 and a general election was held that month. Opposition parties led by the Janata Party banded together and won, as Gandhi badly miscalculated just how much the state of emergency had hurt her standing with voters. Morarji Desai became India’s first Prime Minister that was not from the Congress Party.
Because of the unstable nature of the coalition, Desai only ruled for about 2 1/2 years and resigned in July 1979. His successor Charan Singh was able to form a government with conditional support from Congress, but that support was pulled in early 1980 after only five months. The Janata Party was dissolved in 1980, but former members eventually formed the Bharatiya Janata Party (BJP).
Fresh elections in 1980 saw Congress win an absolute majority and Indira Gandhi became Prime Minister again. On June 6, 1984, the Indian army carried out the controversial and deadly raid on the Golden Temple, a sacred site for the Sikh minority. Shortly thereafter, Gandhi was assassinated by her Sikh bodyguards on October 31, 1984. The Gandhi dynasty continued as her eldest son Rajiv was immediately sworn in as Prime Minister. He called a general election that year and Congress won in a landslide, claiming 414 of the 533 seats in the Lok Sabha.
During Rajiv’s term, a corruption scandal led to the expulsion of former Defense Minister V.P. Singh. Singh went on to form the Janata Dal party and then cobbled together other anti-Congress parties to form the National Front. With the help of the BJP and other parties, the National Front won the 1989 election and V.P. Singh became Prime Minister.
Due to internal strife, this broad coalition was unstable and did not last long. General elections were eventually called for May 1991, and Rajiv Gandhi was assassinated during the early rounds of voting. No party won a majority and so Congress ruled as a minority government, led by P.V. Narasimha Rao. Faced with an imminent economic collapse, Rao oversaw a radical liberalization of the economy that was led by Finance Minister Manmohan Singh. Rao became the first Prime Minister outside of the Nehru dynasty to serve a full 5-year term.
This period of stability did not last long. After Rao’s term ended in 1996, India saw four Prime Ministers over the span of three years. After serving two terms lasting 13 days and 13 months, respectively, Atal Bihari Vajpayee served a full third term after the BJP-led National Democratic Alliance (NDA) won the 1999 elections. In doing so, Vajpayee became the first non-Congress leader to serve a full 5-year term. He continued the reforms started under Rao.
Rajiv Gandhi was succeeded as the leader of Congress by his widow Sonia. While she had never held elected office, Sonia led Congress into the 2004 elections where it became the largest party in parliament. However, it did not have a majority and had to rule in a coalition called the United Progressive Alliance (UPA). Former Finance Minister Singh became Prime Minister and was the first Sikh to lead the nation. Singh continued the reform process that he himself started as Finance Minister. After winning the 2009 elections, Singh’s second term was marred by allegations of corruption.
The 2014 elections saw the BJP win an absolute majority of seats. Indeed, the BJP became the first party since 1984 to win an outright majority with 282 seats, a gain of 166 seats from the 2009 elections. With party alliances giving the NDA 336 seats out of 545, Narendra Modi became Prime Minister and served a full five-year term. Note that Congress experienced one of its worst defeats, winning only 44 seats and 19% of the vote. Rajiv and Sonia Gandhi’s son Rahul currently leads the Congress Party.
The economy is slowing but should respond to increased stimulus. GDP growth is forecast by the IMF at 7.5% in FY2019/20 (ending March 31) and 7.7% in FY2020/21 vs. an estimated 7.2% in FY2018/19. GDP rose 6.6% y/y in Q4, the weakest since Q2 2017. Q1 data won’t be reported until May 31, but monthly data suggest further deceleration. As such, we see some downside risks to the growth forecasts before stimulus measures kick in more.
Price pressures have fallen. CPI rose 2.57% y/y in February, up from the 1.97% trough in January but still well within the 2-6% target range. WPI inflation picked up slightly to 2.93% y/y in February from the cycle low of 2.76% y/y in January. This suggests little in the way of pipeline price pressures.
No wonder the central bank started the easing cycle with a 25 bp hike in the repo rate to 6.25% in February. It is likely to follow that up with a second 25 bp cut to 6.0% this Thursday. It doesn’t hurt that Modi was able to replace the hawkish Urjit Patel back in December with the more dovish (and possible more compliant) Shaktikanta Das. If he does cut tomorrow, his two cuts will fully offset the two hikes delivered by Patel last year.
The fiscal outlook bears watching. The consolidated budget deficit was an estimated -6.6% of GDP in 2018, and the IMF expects it to narrow slightly to -6.5% in 2019 and -6.3% in 2020. However, with elections coming up, we expect the Modi government boosted spending in the run-up to the vote. As such, we see upside risks to the deficit forecasts.
The external accounts are deteriorating modestly. The current account deficit was an estimated -2.4% of GDP in FY2018/19, and the IMF expects the deficit to widen to -2.5% in FY2019/20 before narrowing to -2.1% in FY2020/21. The trade deficit widened significantly last year due to surging imports, but lower oil prices have helped stabilize it in recent months. With oil prices on another upswing, we see upside risks to the current account deficit ahead.
Foreign reserves have resumed their upward trend. Reserves jumped to $406.7 bln in January, the highest since last May but still below the March all-time high of $424.4 bln. They cover over 6 1/2 months of imports and are equivalent to about 150% of the stock of short-term external debt. India’s Net International Investment Position (NIIP) is currently around -15% of GDP. All told, India’s external vulnerability is relatively low.
The rupee is outperforming after underperforming last year. In 2018, INR was -8.5% and ahead of only the worst performers ARS (-50.5%), TRY (-28%), RUB (-17%), BRL (-15%), ZAR (-14%), and CLP (-11%). So far in 2019, INR is up 2% YTD and behind only the best performers RUB (6.8%), CLP (3.7%), COP (3.3%), THB (2.6%), CNY (2.5%), and MXN (2.3%). Our EM FX model shows the rupee to have NEUTRAL fundamentals, and so we expect this outperformance to ebb a bit.
After making a new all-time high near 74.4825 back in October, USD/INR is now trading close to the lows of the cycle near 68.35. The pair is on track to test the June 2018 low near 66.85. However, a clean break below the 67.5385 area would set up a test of the January 2018 low near 63.2465.
Indian equities are underperforming after outperforming last year. In 2018, MSCI India was -0.2% vs. -17.4% for MSCI EM. So far this year, MSCI India is up 7.1% YTD and compares to 13.5% YTD for MSCI EM. Our EM Equity Allocation Model has India at NEUTRAL, and so we expect Indian equities to start outperforming a bit.
Indian bonds are underperforming. The yield on 10-year local currency government bonds is flat YTD. This is ahead of only the worst performers Argentina (+321 bp), Turkey (+132 bp), Poland (+6 bp), and Czech Republic (+1 bp). With inflation likely to remain low and the central bank likely to remain in dovish mode well into 2019, we think Indian bonds will start to outperform more.
Our own sovereign ratings model shows India’s implied rating steady at BBB/Baa2/BBB. Several quarters ago, India was facing downgrade risks to its BBB-/Baa2/BBB- ratings. Now, we are seeing some modest upgrade potential.