Is Narendra Modi an economic miracle-worker? Global investors certainly seem to believe he may be – or at least, that his recipe for India’s deep economic woes may be transformative enough to jolt the country out of its malaise and generate some solid and long-lasting growth.
That’s the rationale behind what has been dubbed “Modi Mania,” a rush of enthusiasm that has propelled India’s stock market into the ranks of the world’s 10 largest for the first time in history, topping those of long-established emerging market South Korea as well as one of the world’s developed markets, Australia, in the process.
The question is whether Modi, now that he has to govern India as its newly elected prime minister, has what it takes to deliver on his election promises.
Investors certainly remain confident. At the time of his election, Indian stocks were one of the best performing national groups in the world, up 15 percent, and easily beat fellow members of the BRIC group, demonstrating yet again the difficulty in trying to think of these four nations as a single bloc.
India may be like China, a nation with a giant and emerging middle class and a seemingly unquenchable demand for raw materials. Also like China, India seems to have hit some limits to its rapid growth of late. Its recent market gains are particularly ironic, however. India may be the world’s largest democracy, but even Indian critics like Amartya Sen have argued that it’s failing to keep pace with China not only in growth but in delivering services to its citizens.
That kind of criticism is precisely why Modi won, and why the prospect of his victory generated so much enthusiasm among investors at home and abroad. As chief minister of Gujarat, he oversaw the highest economic growth in any of India’s states — a feat he has promised to replicate on a national scale.
His ability to do so may be constrained by everything from the nation’s diversity and the fact that he brings with him plenty of baggage (including the reputation for being a rabid Hindu nationalist who turned a blind eye to riots in which more than a thousand Muslims died) to long-entrenched corruption that has become a way of life for the country’s bureaucracy. To get infrastructure and manufacturing projects moving again may require acts of the entire Hindu pantheon of gods.
Even if Modi doesn’t succeed fully in his promises to transform the country, this could well turn out to be a big turning point for the Indian economy. At this stage, any help at all would be good news, given that fourth-quarter GDP grew at an annual pace of only 4.7 percent, the fifth quarter in a row it has fallen below the 5 percent mark. That may seem high by U.S. standards, but compared to recent history, it’s rather gloomy. As recently as two years ago, the economy’s annual growth rate was closer to 8 percent.
Investors have bet heavily on Modi’s reforms. The mid-May election results drove the country’s stock market index to record highs, but investors began placing their chips on the table months ago, even if few predicted the magnitude of the victory Modi and his pro-business Bharatiya Janata Party (BJP) actually registered.
The surge has lifted the MSCI India index 23 percent on the year. Based on valuation metrics, Indian stocks no longer look cheap. They now trade at a significant premium to shares in other emerging markets, BlackRock’s Global Chief Investment Strategist Russ Koesterich wrote earlier this month. “While there are reasons for optimism, current valuations seem to already reflect a lot of good news,” Koesterich noted.
Just as important, it’s not clear where a new wave of buying might come from. Emerging market mutual funds are already heavily overweight Indian stocks, and may be running out of room to further boost their allocations to this area, according to a number of recent surveys. And what kind of dramatic news — like Modi’s victory at the polls — might inspire anyone to increase their allocations still further, driving stock prices to fresh records?
Even as the stock market has soared, corporate earnings, on which valuations hinge, have proved disappointing. Even when companies have reported better results, they have been attributable to tax credits and other factors that can’t be traced to higher revenues and improved operations. That suggests fundamentals still trail the market’s valuation.
Modi’s triumph in the elections may be one form of miracle, but winning an election isn’t like turning around the economy of an entire nation, especially one that is so sclerotic and in need of reform as that of India. Almost certainly, prolonged periods of disappointed expectations lie ahead; it will take time for improvements to the economic infrastructure to prove lasting and contribute to higher corporate profits.
Riding the “Modi wave” has been profitable so far, but, like so many waves, it’s bound to be choppy.
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