Friday, November 22, 2019
Home > Production > India Stocks: Political risk will be the top catchword for investors

India Stocks: Political risk will be the top catchword for investors

Political risk will be the top catchword for investors in India over the next two months as the country moves into full-blown rhetorical election campaign mode. With the last parliament session winding down decision making has come to a standstill in the run up to the national polls in the world’s largest democracy until a new government takes over in May.

This puts to rest any hopes of a quick recovery for an economy that is limping along at its slowest pace in a decade, with growth expected at below 5 per cent for the second consecutive year. The collapse of growth from well over 9 per cent in the Congress-led coalition government’s first term in office is widely expected to dent the fortunes of the ruling alliance in the general elections.

While opinion polls show mounting popular support for the main opposition Bharatiya Janata Party (BJP), led by charismatic but controversial Narendra Mody, he is unlikely to grab a majority in the 543-seat Lok Sabha or the House of People, the main law-making lower house of parliament that decides who forms the government in New Delhi.

The most plausible scenario is a BJP-led alliance taking over the reins, a possibility that would warm the global and domestic investors because of the 63-year-old Mody’s free enterprise credentials in running the state of Gujarat for more than a decade. However, it is foolhardy to predict election verdict in the subcontinent because of powerful and numerous regional groups.

Global investment bank HSBC realised this when it held its annual India conference in Mumbai recently. “We quickly realised the topic on everybody’s lips was the general elections. From companies speaking at the conference itself to taxi drivers, it was impossible to get away from election talk and discussion of the myriad potential outcomes,” it said in a report.

Participants at the conference included some India’s top companies such as engineering and construction conglomerate Larsen & Toubro, top private-sector lender ICICI Bank, leading motorcycle maker Hero MotoCorp and the biggest mobile service operator Bharti Airtel.

“It was clear that most companies have put major investment decisions on pause ahead of the elections. Bureaucrats too appear to have stopped signing off on new infrastructure contracts, as they wait to find out who their new leaders will be. It is as if all of India’s decision makers are collectively holding their breath,” HSBC said.

Why elections weigh heavily on the investing classes in India is because government policy changes like tweaks in excise or other tax levies as well as controls could seriously mar the fortunes of companies. The socialist moorings within the political landscape and the innate urge to play to the galleries are big risks.

The Aam Aadmi Party (AAP), or Common Man’s Party, which rode to power briefly in the state of Delhi on popular support for its anti-corruption plank, slashed power tariff by half and gave free water to many households without waiting to see an audit report ordered into the electricity distribution companies to check if they were making undue profits.

Such kneejerk decisions not only destroy companies that have pumped billions of dollars into their ventures but also scare away potential investors. Last September the central government opened up the retail market and allowed global chains such as Wal-Mart and Carrefour to set up shop. However, no investment is likely to happen because of tight regulations still in play and political opposition in some states.

The AAP in Delhi and the BJP that won power in Rajasthan in December have both struck down foreign direct investment in the retail sector in their respective states. Such about-turns with a change in government are bound to damage the investment climate, and there will be a heavy price to pay in the longer term.

“We believe the visibility on earnings growth and asset quality is hazy given the fluidity around the political outcome which is keenly watched by investors due to the ongoing policy paralysis and challenging macro,” Goldman Sachs said in a note to clients on India’s financial sector.

“We therefore recommend investors to remain cautious on the sector and wait for political clarity, even if it may mean giving up potential initial gains. We believe the downside risk from an unfavourable political outcome outweighs upside risks from a favourable political outcome. We are concerned that an unfavourable political development could lead to an increase in impaired loans much higher than our current estimates.”

The US bank said this would lead to higher provisions and further strain the profitability, especially of government-run banks. Non-performing loans of banks in India are significantly higher than in other Asian markets, while their provisions are much lower, leaving them susceptible, it said.

“While the economic outlook remains uncertain, businesses give us the impression they want to get back to spending and investing after the elections, irrespective of who is in charge of the country,” HSBC said.

“However, with the elections nearing, we also feel that there could be considerable volatility in Indian equities, with the upside and downside determined partly by the outcome of the elections.”

Nonetheless, there is a glint of hope for some sectors as a cyclical recovery suggests that earnings could rebound in the second half of the year.

Equity holdings by investors in companies show a large degree of polarisation towards safe-haven sectors such information technology, pharmaceuticals and consumer staples, while ownership levels in core sectors of energy, metals, industrials and utilities came off sharply in the past five years, HSBC said.

“In our view, the completion of elections could spur rotation into under-owned investment-oriented sectors even as overall flows remain subdued against the backdrop of a Fed taper.”

“We therefore like exposure to some high-quality cyclical names such as ONGC, L&T, Sesa Sterlite, Bharti and Maruti.”

The writer is a journalist based in India