Riding on the Modi effect

Indian stocks have been enjoying a strong rally following the landslide victory by the opposition Bharatiya Janata Party. So how long will the ride last? Is it too late to get in on the action? And what does it mean for you as an investor?

Since voting started in April till Narendra Modi’s swearing in as prime minister, about six-weeks later, the SENSEX gained 11% to hit all-time record high of over 25,000 points, more than 16% year-to-date.

Incidentally in contrast, news of the electoral victory by Modi's predecessor, Manmohan Singh, in 2004 saw a ‘bloody Monday’ when the SENSEX reopened and dipped over 11% by more than 500 points.

This compares with relatively more subdued global markets elsewhere over the same period, such as the Dow Jones, S&P 500, Hang Seng, Nikkei and STI. The pro-business reforms promised by BJP leader Modi are expected to fuel growth in various sectors.

On the equities front, the positive business sentiment has already given a lift for banking counters such as ICICI and SBI. With the government likely to rein in inflation, we could see higher interest rates which could also give banks a lift from margins. Of course assuming borrowing activity does not drop off too much from being too expensive.

Likewise the construction sector has seen some uplift, especially in stocks such as Larsen & Toubro and Shree Cement both of which look poised to benefit from infrastructure projects with upcoming reforms.

Along with plans to push economic growth, we are likely to see reforms for certain industries to make them more competitive and efficient by opening up markets for foreign investment. One of the likeliest candidates for reform is the coal industry.  

Modi will be under pressure to ramp up the sector’s production and efficiency to address the choppy electricity supply across the country, which relies on coal for more than half of its power. He will also be faced with opening up the industry to global exports. However, questions remain over the demand for India’s relatively inferior coal and the speed of reforms.

Investors have already started to bid up stocks such as Coal India, which currently enjoys a monopoly in the country. With reforms also expected to be in the pipeline for rail infrastructure, the coal sector could be poised to benefit from greater demand.

Rupee rebound

What has also rebounded since Modi’s ascension is the Indian currency, partly due to his expected fiscal policies. ‘The rupee reflects the strength of the Indian economy and a declining rupee only showcases the fact that we as a nation are living beyond our means,’ Modi told local media.

The rupee, which fell sharply in late 2013, has risen by over 5% against the USD so far this year making it the best performing EM currency in Asia. This was ahead of the Indonesian rupiah, South Korean won and the Malaysian ringgit which have gained between 2 to 4%.

While the stronger rupee might benefit importers, companies such as IT service providers are likely to see earnings eroded as a huge part of their earnings are derived from overseas markets and are denoted in USD.

The INR rally could be sustained until the next budget is revealed, and could be extended further if investor expectations are met or even exceeded.

This might have a double edged effect. It will become appealing for foreign direct investment in the SENSEX and private enterprise which will bid up the INR even more, but will the central bank have to intervene in the currency, to assist in Modi’s plans for great domestic economic freedoms and prevent India from being uncompetitive?

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