The initial reaction to the general election results was negative, with the Nifty index falling 5.9% on June 4, though the market ended the last quarter up 9.7% from that day’s close. The initial reaction was not surprising as it was a real surprise that the BJP failed to win the 272 seats to run the government on its own.
Brokerage firm Jefferies noted in a recent note that coalition governments are inherently chaotic and the BJP’s failure to secure a majority is a negative since the strength of Prime Minister Narendra Modi’s first two five-year terms was his single-minded focus on pursuing policies. The question is therefore whether Modi can function as effectively in a coalition government.
Going forward, the brokerage believes there is a risk of another market correction, which is the biggest risk for the mid-cap sector.The Nifty MidCap 100 index is currently trading at 32.2 times one-year forecast earnings, compared with 20.6 times for the Nifty.
Meanwhile, while the past decade has been characterized by budget deficits driven by spending on physical infrastructure rather than transfer payments, the view that the new government will focus on populist policies means investors will be tempted to tilt their portfolios towards consumption rather than investment, they predicted.
This will become clearer in the budget due to be presented later this month when the monsoon session of Parliament begins. The new coalition government is reportedly considering more than $10 billion in consumer stimulus packages. ₹Jefferies added that the next budget will include 5 trillion rupees ($6 billion), including tax cuts for low-income earners.
Jefferies also believes that a portfolio realignment in favour of consumer goods, especially rural investments, could make some tactical sense. Still, the base case is that India is in an up cycle of real estate and capital investments.
In this regard, Jefferies’ head of India research, Mahesh Nandurkar, noted in a recent report that the BJP’s shock defeat in 2004 offers an interesting precedent: the Nifty fell 19% in the three days following the election results, but the then nascent capital expenditure cycle gained momentum and Indian markets rose 43% over the following 12 months. If a similar pattern plays out, Jefferies believes the recent election results could dampen the likelihood of state-owned enterprise reforms and public sector disinvestment, which investors had expected Modi to prioritise in a third consecutive term for the BJP government.
FII and DII flows
In the months leading up to the election, stock markets were driven by a surge in retail inflows. Jefferies India estimates that total domestic retail inflows into Indian equities, including direct retail trades, mutual fund inflows and other inflows, reached a massive $7 billion per month in the first five months of the year as investors discounted expectations of a BJP landslide victory.
The net inflow of domestic stock investment trusts was ₹15,600 crores (US$ 1.9 billion) per month in 2023 ₹30,300 crore (US$3.6 billion) per month for the first five months of 2024.
Jefferies noted that even if there is a risk that stocks could fall again, there is one big positive from a capital flows perspective: Indian stocks have performed well in recent quarters, coupled with high valuations, especially for mid-cap stocks, means that most emerging market aficionados are no longer overweight in the market, and foreign investors will view any significant correction as an opportunity to add, the firm noted.
In fact, foreign investors were net sellers of Indian stocks in the last quarter. They made net purchases of $1.36 billion in the first quarter of 2024 and $21.4 billion in 2023, followed by net sales of $1.2 billion in the last quarter, but importantly, they have made net purchases of $4.95 billion since June 7, Jefferies added.
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From a macro perspective, Jefferies India is forecasting annualised profit growth of 16 per cent for FY24-26. Meanwhile, the main negative factor in the recent earnings season was a 31 basis points YoY decline in the banking sector’s net interest margins, which fell from 3.7 per cent in Q4FY23 to 3.4 per cent in Q4FY24 for the eight banks tracked by Jefferies, despite healthy loan growth of 16 per cent.
According to brokerages, this is probably already priced in by the poor performance of private sector banks in recent quarters. The Nifty Private Bank Index has underperformed the Nifty by 11% since mid-May 2023. The banking sector also faces near-term challenges, namely recent regulatory pressure from the Reserve Bank of India to slow retail sector lending growth, especially in the area of unsecured loans, and to “control” loan-to-deposit ratios.
Finally, from a monetary policy perspective, the RBI has the scope to cut interest rates if necessary. The real policy repo rate, deflated by the CPI, is currently at 1.7%. Still, like other central banks in Asia, the RBI is waiting for the Fed’s decision.
Disclaimer: The views and recommendations expressed above are those of the individual analysts or brokerage firms and not those of Mint. We recommend checking with a qualified professional before making any investment decisions.
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