India’s macro advantages are independent of government: MUFG Bank report

The report by the Japanese bank suggests that there won't be any dramatic changes in the Indian market after a govt change as they are mostly independent of the government.
Image used for representation.
Image used for representation.

Arguing that a weak coalition government either led by the BJP or the Congress will not lead to massive macro risks but instead will lead to more meaningful policy changes, even though it will create short-term market mayhem, a foreign brokerage says that some things will not change in India as most of the good things here are independent of the government of the day.

In a weekend report, analysts at the largest Japanese lender MUFG Bank, said, “While market sentiment will no doubt take a sharp hit in the event of a change in government or a weak coalition, it’s important to remind ourselves that many good things are going for India that are independent of the government of the day.”

These good things include the cumulative impact of past reforms, global push factors such as supply chain diversification to India and the surge in digitalization, along with good demographics, a large educated population and a large domestic market.

On the impact of a weak coalition led either by the BJP or Congress, the reports say while there will be “sustained volatility in the rupee and equity markets for the short-term." There will be more meaningful policy changes could come if there is a weak coalition or a change in the government. But it does not name the positive/meaningful changes.

But they quickly added a caveat that “this is not to say that policy shifts will not have an impact, but it’s certainly to say that we should not swing too far in either direction in longer-term assessments” in the event of a surprise poll outcome either way.

Explaining why they don’t see major macro risks, especially in terms of the structural prospects and reforms even if a weak government takes over, they say “we’ve long been positive on India’s structural prospects due in part to the cumulative impact of reforms taken by the current government.

“These policy measures include the GST rollout that has increased formalisation of the economy and has reduced internal trade barriers, and the direct benefit transfer programme introduced before 2014 that has improved targeting of government subsidies and transfers to beneficiaries. Along with these are other key legislation and policies such as the Insolvency and Bankruptcy Code, the real estate law and the acceleration of public infrastructure spending which have helped reduce logistic costs over time.

But if the next government is a very weak coalition, it can lead to “a slowdown in fiscal consolidation, more support for consumption spending, slower public infrastructure execution, together with a relook at incentives to attract manufacturing, all of which could combine to increase policy uncertainty.”

In this eventuality, the rupee can see a 1-3 per cent sell-off to 84-85 to the dollar, and equities could decline “meaningfully”.

If at all BJP is unable to make it to the 400-target, but wins a comfortable majority of over 272 seats, “we think markets should still view the outcome positively over time. There could be modest knee-jerk weakness in the rupee and risk assets if BJP loses some seats but still has a majority as this weakness should reverse over time as there will still be policy continuity in crucial areas such as infrastructure, investment attraction, fiscal consolidation, and inflation management in such a scenario.

And if the BJP gets more than its 2019 tally the markets could be on a song as “a greater seat share for the BJP would increase the ability to pass more contentious structural reforms in land, labour and the agriculture sectors.

Discounting the marginal fall in voter turnout, the report says this has more to do with the heatwave conditions across the country along with voter apathy due to the extended timing of the polls. Moreover, historically there is no evidence showing any clear relationship between overall voter turnout and anti-incumbency in the elections. Indeed, data since 1951 suggests that there were eight times an incumbent government lost, and this sample was equally split between increases and decreases in overall voter turnout rates.

If history is any guide, the short-term market impact of the elections will depend on the strength of government mandate relative to polling expectations. And the classic example of an outsized market move was in the 2004 elections when the Congress wrested power from almost sure BJP win. As a result of the complete surprise BJP loss, the Sensex tanked  17% the next day, and the rupee lost 2%  over the next months, while the 10-year bond yields rose by 150 bps at one point as markets built in higher fiscal spending.  

Again, conversely, the 2009 polls leading to an again surprise return of the Manmohan Singh government, the Sensex greeted the news with an over 10% rally the next day which continued for the rest of the second term. And the 10-year benchmark bond yields gradually ended higher.  Similar was the outsized market moves in 1984 after a strong mandate by the incumbent Rajiv government.

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