What does Modi 2.0 mean for markets? UBS’ Gautam Chhaochharia and Tanvee Gupta Jain attempt to connect the dots

Even though the leadership and policy continuity matters, the state of the domestic economy and the potential impact of tariffs on the global economy loom large

Staff Writer May 25, 2019

The thumping majority for the ruling NDA dispensation with over 350 seats is the largest mandate for an incumbent government since 1984. Whether or not this mandate endorses the policies of the incumbent government is debatable from a political vantage point, but the markets are hoping this would give a continuity in economic policy making and a ground for unleashing more economic reforms.

On May 23, as the results started pouring in, the Sensex had surged 900 points to cross 40,000 for the first time ever. The Nifty also hit record highs. But both indices gave up their gains later to close slightly weaker. But on Friday, the markets rallied again to close 1.64% higher.

This zigzag movement shows there is some confusion on what Modi 2.0 will do. We will surely know more when government formation in terms of Cabinet is in place, and PM Modi’s announcements come as he lays down the agenda for next five years. Gautam Chhaochharia, Analyst, UBS Securities India Pvt. Ltd., Tanvee Gupta Jain, Economist, UBS Securities India Pvt. Ltd and team have deciphered what PM Modi will do now. Read on.

Near-term growth vs. macro stability

What will be PM Modi’s immediate focus? Will it be focused on reviving growth in the short term or on clean-up/structural reform to achieve sustainably higher growth over the medium term?

“After the big win for Mr. Modi, market moves will be driven by the following: 1) Policy choices to revive near-term growth vis-à-vis ensuring macro stability. These matter for the earnings growth cycle. 2) Reform narratives matter for multiples – half of the last 5 years’ NIFTY returns have come from re-rating. Our new base case is Nifty of 12,000 by Dec 2019; our upside/downside scenarios are 13,000/ 10,500,” says Chhaochharia and Jain.

Over the near term, given PM Modi’s strong mandate, hopes will be high about the reform narrative. This will matter in the context of rich multiples and may continue to overwhelm any near-term growth disappointment. What this reform exactly is will matter and narrative-building on that in the next few weeks merits tracking. “Of course, actual implementation of the same may take longer,” the UBS team point out.

Stimulating growth faces fiscal challenges

Given the recent slowdown, boosting growth may appear to be a priority but will depend on the political economy’s view of the Government. This has macro stability implications (focus on keeping inflation low may continue) and fiscal space is limited.

“Potential near-term options from our investor discussions: 1) expansion of direct income support to farmers ; and 2) GST rate cuts. Off-balance sheet financing of infra may also be peaking. Public capex hopes may face disappointment,” says the UBS team.

Financial system recap?

Is recapitalising the system by RBI dividend a panacea, many ask. Resolving issues in the financial system of: 1) NBFC stress; and 2) catalysing credit growth for SOE banks remains a big hope to revive growth.

“A staggered dividend of ~US$10bn per year, rather than a one-shot US$30bn, is our base case. Trade-off with macro stability (inflation) will merit tracking,” the UBS market experts say.

Reform: Big bang or incremental

Major structural reform on land, labour and privatisation will excite markets. Political capital is higher vis-à-vis 2014 but a majority in the upper house (Rajya Sabha) is unlikely by 2022. Announcement of an Air India privatisation and building a narrative on land/labour reform are possible, although SOE (state owned enterprise) Banks’ privatisation remains unclear.

How to position

UBS analysts have pencilled some scenarios. These scenarios oscillate between a mix of big bang vs. incremental reform and staggered vs. a one-time RBI dividend payout.

“Our base case is of incremental reform plus a bit of big bang and a staggered RBI dividend. We remain Underweight industrials, reflecting our view on the capex cycle, as well as SMIDs, as they may do well only in our upside scenario,” say Chhaochharia and Jain.

Rupee reign

The INR’s negligible price action (since the exit polls) is a reminder that while leadership and policy continuity matters, the state of the domestic economy and the potential impact of tariffs on the global economy cannot be ignored.

“From an external risk perspective, we think even though INR’s exposure to a potential global trade slowdown is low, it is not positive. On domestic risks, an imminent source of worry is slowing domestic activity amidst rich equity market valuations and foreign investors’ positioning,” says the UBS team.

Staff Writer

This article is written by RupeeIQ editorial staff.

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Mohammed Haseeb