Share prices follow the profits of businesses. If companies clock a strong earnings growth, share prices will continue their march upwards. India's general election has already fueled a rally in anticipation of the victory of Narendra Modi and the incumbent National Democratic Alliance. The NSE Nifty has nearly doubled over the past five years. The broader market has done even better, with the Nifty 500 index outperforming the Nifty during the same period. That shows the confidence investors have in Narendra Modi's election win. They expect company profits to continue to flourish.
When the same government is re-elected, there is minimal policy uncertainty. Stock markets do not like a phase with policy flip-flops or uncertainty. That could be related to direct and indirect taxation. It could also mean that the government policy should change the norms of spending more on giveaways and less on capital expenditure that triggers economic activity.
Relative policy certainty
After two successive terms in office, investors have a sense of the policy framework of the Narendra Modi government. There is no slowdown in the overall welfare spending through food security or the job guarantee scheme. However, investors like the quality of the government expenditure. The Modi government has successively bumped up spending on infrastructure. The government is creating new employment and a chain of economic activity by building new roads, airports and bridges. Stock markets have probably priced in the higher allocation towards capital expenditure in their estimates. At the same time, they expect the new government to continue with the momentum. As more money is allocated towards physical infrastructure, the prospects of companies that rely on sectors that depend on such policies are better. These include engineering, construction, steel and other related metals, cement, and infrastructure. The government has worked with states to create modern urban infrastructure in many cities through metro rail, roads, and bridges. According to press reports, there are ongoing infrastructure projects worth Rs 5,00,000 crore* in the Mumbai Metropolitan region alone. Similar initiatives are active in many other cities and states. The Modi government is expected to boost such ideas further in the third term.
Government finances
The other key parameter is the management of the government finances. The Modi government has kept the fiscal deficit in check despite a surge after the COVID-19 pandemic. There is an emphasis on fiscal responsibility. That means the government is not looking to enhance market borrowing and pressure interest rates. Aggressive spending on revenue-related expenditure stokes inflation. The government is looking to cut market borrowing and rely more on tax compliance and revenue from direct and indirect taxes. That helps the financial system as there is more money for business expansion and individual borrowing. There is an active effort to keep the consumer price inflation in check. That matters as it helps everyone reduce borrowing costs. Low-interest rates are generally a trigger for the economy. Businesses can then rely on domestic credit and reduce dependence on foreign credit. At the same time, they can expand capacity at will. The Modi government has enabled a stable interest rate regime.
Key reforms need to continue
Stock markets are eyeing more economic reform initiatives in the third term. Some critical economic reforms have been stalled. These include disinvestment. The Modi government came to power in 2014 with a promise of minimum government and maximum governance. However, government ownership in business is now higher than ever before, thanks to capital infusion in public sector banks and companies. While it has brought stability to the banking sector by reducing non-performing assets, investors look forward to strategic and gradual disinvestment in public sector companies. The intervention was necessitated during the pandemic, but the stock market investors would like to see the government gradually reduce ownership. That would allow space for entrepreneurs to take risks and innovate. India's export potential is much higher than $768 bn annually. The Modi government, in the third term, is expected to create a conducive environment to boost manufacturing and services export growth. India has already offered production-linked incentives to multinational corporations. There is also a thrust on pushing for districts as export hubs to take on the challenge from other competing countries like Vietnam. The export potential of small business enterprises would also require a significant boost in the third term.
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Conclusion
The stock market is pricing in a third term for the Narendra Modi government. They expect the government to create an enabling environment for businesses to push India's economic growth and stay on track to becoming a developed nation by 2047. For now, continuity in policy is paramount for investors.
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