Modi is long on India but...

It’s a good three and a half years to the next Lok Sabha elections. However, what will transpire in the Indian Parliament over the next two-three years may impact the outcome of the 2019 elections. How various political parties are likely to behave to maximise their chances of winning the 2019 elections may to an extent impact the real economy and to a large extent the Indian equity market. Among the possible reasons for investors' willingness to pay a premium for Indian stocks has been the assumption of faster economic reforms. This in turn was based on the premise of the ability of a single party, with majority mandate, to push through reforms, since coalition politics was assumed to be all but dead.

However, both these assumptions may require a rethink. Possibly, the least important implication of the Bihar electoral results is that the BJP-led National Democratic Alliance's (NDA) seats in the Rajya Sabha will not increase immediately. Thus, the ruling coalition will continue to face challenges to pass bills in the Rajya Sabha. For long-term market participants, the more important point is the possibility that coalition politics may be revived at a nationwide scale after BJP’s defeat in Bihar against an opposition coalition.

While India’s economic growth would for some time remain higher than other emerging markets (EM), in the absence of reforms, the upside may be capped. Hence, one can question the significant premium Indian equities enjoy over other EMs. In the absence of reforms, can one justify the price-earnings (P/E) ratio of 14-15 given to the Indian market while other prominent EMs have single digit P/E ratio? Investor action till the February 2016 Budget will be an indicator of whether the ‘single-party’ premium is still in play.

United we oppose

The Bihar elections bring home the point that a pre-electoral alliance of parties opposing NDA may cause significant damage to its electoral prospects. BJP’s massive Lok Sabha victory in 2014, owes a lot to the emergence of Narendra Modi as an inspirational national leader as well as to charges of corruption and in-decisiveness of the erstwhile Congress-led UPA (United Progressive Alliance). However, in hindsight, it may be argued that if most parties — which were at various points in time part of the UPA — had formed a pre-poll alliance, the seat differential between NDA and UPA may have been lower.

It is not a far-fetched scenario. Inspired by the Bihar results, the parties opposed to NDA may form a pre-poll alliance for the 2019 Lok Sabha elections. Say, NDA’s vote share in 2019 remains exactly the same as it was in 2014 (38.5% of valid votes polled). If major constituents of UPA form an alliance and they also get the same vote share as was the case in 2014 then such an alliance may get anywhere between 30% to 40% of the votes polled.

Thus, if at all, a coalition of opposition parties is formed, it will be challenging for the NDA to increase its seat count. Under a scenario that all parties who were ever part of UPA-I or UPA-II come together and people vote exactly the same way they did in 2014, such an alliance may actually win more seats than the NDA. Given that at least on paper, there is a possibility of a mega-opposition alliance which may challenge the NDA, the BJP’s best bet is to work on increasing its share of votes.

‘Rational’ thinking

Globally, political parties like most entities are driven by self-interest. Like most entities with self-interest, they adopt a ‘rational’ approach which will maximise their objective function. The objective of most political parties is to win an electoral mandate to rule till the next elections. While this may sound utilitarian to the point of being narrow, per se there is nothing wrong with it.

It is with respect to this political utility function that one may propose that the NDA-led by Modi is long on the Indian economy. If the Indian economy palpably (and not just in terms of numbers) improves over the next three years then more Indians will be convinced of Modi’s growth model. This may improve NDA’s vote share in the 2019 election, to the extent that even if its opposition forms a mega-alliance, NDA will retain the majority in the Lok Sabha. For this to happen, critical reforms must be enacted. While the actual economic impact of any reform will play out in the long term, in the short to medium term they improve certainty about the future and are thus, likely to support the stock market and along with it, the positive sentiment with respect to the government.

However, for the opposition parties, an adverse economic scenario will help them gain vote share against the incumbent ruling party and possibly win more seats. No matter how deplorable, it will be ‘rational’ for them to oppose reforms and dent sentiment, if not the actual economy.

Games going forward

The set-up is that of a Game-Theory application at a nationwide level. Obviously in such situations, the equilibriums are difficult to determine but crystal gazing throws up three possible scenarios:

A)    Win-win situation for India: The political class across parties behaves with maturity. Which implies that for the ruling coalition, its fringe elements do not give the opposition any tool whatsoever to disrupt Parliament. The opposition in turn discusses issues on merit in Parliament and at least most of the major reforms are passed with consensus. This gives stability to the economy, investors feel comfortable and continue to pay a premium for Indian equities. BJP gets a majority in 2019, however, opposition parties by exhibiting maturity clawback some seats. This may be the best scenario for BJP. Even if the fringe elements of BJP are controlled and the opposition stalls Parliament, it is possible that the electorate may end up supporting BJP for its efforts and condemn the opposition.

B)    Win some-lose some: Under this situation, only the bills which are more or less apolitical in nature such as the Bankruptcy Code, Real Estate Regulations bills and with some luck Goods & Services Tax (GST) get passed in Parliament. However, bills which may be politically sensitive such as labour reforms or the land acquisition bill may not make headway. Under this situation, foreign investors may be placated temporarily but the premium they are paying may be moderate. The anti-incumbency factor may become more prominent and the BJP is unlikely to repeat its 2014 performance.

C)    India loses: The political class shows callousness and immaturity making the world feel that India has elements of a banana republic. The fringe elements of the ruling coalition by their actions continue to provide ammunition to the opposition to stall Parliament. Hardly any meaningful bills get passed. This may make investors reluctant to give any premium to Indian equities over other EMs and trigger a major fall in the benchmark indices. As FIIs pull out of Indian equities, the rupee may weaken which may limit RBI’s ability to reduce the interest rate. The real economy also starts getting affected. There will be a strong anti-incumbency factor against NDA and if there is any opposition alliance then NDA may be surprised adversely in 2019 elections. This may be the worst-case scenario for BJP and the best-case scenario for its opposition. 

The author is a visiting faculty at IIM Calcutta. Views are personal.