India Equities Rally: Investor Optimism Over Elections May be Misplaced

Optimistic investors are returning to India's $1.2tn equity market, amid forecasts that the opposition Bharatiya Janata Party (BJP) will win elections and deliver a government that can revive economic growth from a decade low, but analysts advise caution.

Analysts want investors to tread with caution given that the current level of optimism does not correspond with the fundamentals of Asia's third-largest economy.

Investors are betting on the BJP's prime ministerial candidate Narendra Modi, who supervised annual economic growth of 10% as the head of the Gujarat state since 2001.

India's benchmark share average – the S&P BSE Sensex – has risen 7.04% this year.

However, any new government, "will have to do something dramatic to replicate the current [market] run-rate" post elections, Shubhada M Rao, senior president and chief economist, Yes Bank, told IBTimes UK.

The market rally is not "commensurate with the fundamentals of the [Indian] economy as yet," Rao said in a telephone interview.

"Investors [eyeing the Indian equity markets] should be more cautious than the current optimism suggests," said Miguel Chanco, India economist at Capital Economics.

"The most optimistic polls still see the BJP requiring coalition partners to form a government. Governing within a coalition is likely to mean that a BJP administration at the centre may face difficulties implementing far reaching reforms.

"In addition, we caution that the BJP is not entirely the free market stalwart it is often perceived and portrayed as. For example, it has opposed the entry of foreign investment in the multi-brand retail sector, which is a position it reiterated specifically in its manifesto for this election cycle," Chanco said in an e-mail to IBTimes UK.

"With these in mind, we think the current optimism is going too far, in our view, especially considering the recent heights the market has hit over the past few weeks.

"Apart from the uncertainty regarding the elections, it is worth remembering that India still has a lot of macro economic and business environment problems that are unlikely to be solved over night, such as high inflation, a high fiscal deficit, rigid labour laws, infrastructure deficits, etc," Chanco added.

"A strong coalition is a pre-requisite for investor confidence to build. That's a necessary condition. A performing government is a sufficient condition," said Rao.

"[India] needs result-oriented decision making. Performance and policy are essential for [investor] confidence to stay alive," she added.

"I still see 2014 as a year in which emerging market economies with large foreign borrowings like India's are vulnerable," said Bill Adams, senior international economist for the PNC Financial Services Group.

"From an international perspective, some of the change in sentiment toward Indian assets is probably related to the stabilisation, and now today, decline of US benchmark interest rates. Lower US interest rates increase the premium earned on Indian financial assets relative to assets seen by investors in industrial economies as risk free.

"I expect US interest rates to turn a corner and rise again in the coming months, which would bring back the driver of Indian capital markets' 'awful August' of 2013," Adams said in an e-mail to IBTimes UK.

Modi has promised to boost investment if he takes power from South Asia's longest serving prime minister, Manmohan Singh.

Growth in India has dropped from a high of about 9.6% in the fiscal year 2006-07 to a decade low 4.5%.