After Indias Election, Execution takes Center Stage for Debt Markets

Financial markets in India have already rallied strongly in anticipation of the overwhelming majority win by incoming Prime Minister Narendra Modi and the Bharatiya Janata Party (BJP). The country’s currency (the Indian rupee) rose 15% from its August peak, while five-year credit default swaps on the State Bank of India (SBI) tightened from a spread of 371 to 207 in the same period. We believe further upside for Indian assets in the longer term depends on the execution of the party’s campaign promises to deliver firm governance and economic- and market-friendly reforms, and to focus on growth, jobs and investment. This will include:

  • Establishing the groundwork for urgently required  infrastructure development.
  • Creating very urgently needed quality jobs for India’s rapidly growing working-age population.
  • Establishing conditions necessary to transform India into a global manufacturing hub.
  • Controlling inflation, currently at 8.6%.

Most positive for debt markets, we think, will be the likely reprieve from rating agencies on the country’s investment-grade sovereign external rating.  We think Standard & Poor’s may eventually revise its outlook on India’s BBB- rating from negative to stable once the new government demonstrates its ability to stabilize growth while maintaining the downward trajectory of its twin fiscal and current account deficits. Moody’s Investors Service, meanwhile, has indicated that an upgrade from its current Baa3 rating is a possibility in the medium to longer term.

In order to successfully placate India’s electorate while maintaining much-needed fiscal consolidation, we think the new administration will need to focus on both improving the general quality of fiscal expenditures  and taking measures to improve fiscal revenues, which stand among the lowest in Asia. Such measures could include revisiting tax reform and selling additional stakes in public sector enterprises.  Equally important, we believe, will be measures aimed at establishing clarity for long-term private investment: cutting red tape, improving transparency in environmental clearances and improving coordination between federal and state governments for large-scale projects.  No less important, we will look for signs that the incoming government will endorse highly respected Reserve Bank of India Governor Raghuram Rajan in his effort to establish credible inflation-targeting despite the necessary near-term side effects of sustained high benchmark interest rates.

During his 13-year tenure as Chief Minister of Gujarat, Mr. Modi built an impressive track record of eliminating the kind of red tape endemic in every layer of government. Nonetheless, his encouraging and much-repeated mantra of “minimum government and maximum governance” points toward what we believe will be much-needed efforts to improve what is one of the world’s worse climates for doing business, to improve the country’s woeful infrastructure and, at the same time, to institute fiscal prudence while also somehow focusing on generating the necessary higher-than-average growth given India’s demographics.

The market favorite BJP won India’s 2014 general election with the likes of a landslide not seen in 30 years. Nonetheless, we believe enforcing the same brand of elusive governance and functionality at the national level is by no means a given – markets will focus keenly on execution every step of the way.

All data provided by Invesco unless otherwise noted.

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