Investing into India’s fourth sine wave

Posted online: Monday, Mar 17, 2014 at 0000 hrs
With the Indian stockmarket having rallied by ~7% over the past 30 days, with the broader economy still showing no signs of an economic recovery and with the General Elections in India less than a month away, is there a case for investing in the Indian market?

Our analysis of the political as well as economic dynamics in India over the past three decades suggests that the case for investing in India before the markets discount the election-specific outcomes is overwhelming.

India has traversed three ‘sine waves of economic growth’ over the past three decades 

History suggests that India has undergone three distinct waves in its ‘politics’ as well as ‘economy’ over the past three decades. The synchronisation between the political and economic cycles is extraordinary and points to the interconnectedness of the two aspects of India.

The remarkable synchrony between political and economic cycles in India

The first sine wave of economic growth (FY85-92) was catalysed by the Congress’s landslide victory in the 1984 elections. The economic reforms which Indira Gandhi had already kicked-off prior to her assassination combined with incremental reforms under the new PM, Rajiv Gandhi, gave India its first growth boom and a strong stockmarket rally. 

The second sine wave of economic growth (FY93-03) was catalysed by the formation of a Congress-led minority government headed by a proactive Prime Minister, PV Narasimha Rao, in 1991. The formation of this government combined with the tailwind of economic reforms administered in CY91 led to the second sine wave of economic growth in India accompanied by the scam-riddled stockmarket boom in the early 1990s.

The third sine wave of economic growth (FY04-14) was catalysed by the formation of the UPA government in the 2004 General Elections. The formation of a government with a clear majority combined with the tailwind of reforms administered by the NDA led to the materialisation of India’s biggest economic boom alongside an exuberant stockmarket. 

India appears to be on the cusp of the ‘fourth sine wave of economic growth’

India’s three decade long history makes it evident that each of the sine waves is characterised by remarkable similarities.

Firstly, each sine wave of economic growth has begun with the conclusion of a General Election. History suggests that whilst every General Election may not necessarily trigger an upswing in the GDP growth rate, if the conclusion of the General Election is accompanied by a tailwind of economic reform then the birth of a sine wave of GDP growth is almost certain. In other words, the second commonality across these sine waves is that each sine wave has been preceded by economic reforms that have been administered over the “down” phase of the last sine wave (see chart).These often go unnoticed when administered, as GDP growth continues to nose-dive and the political leadership is focussed on the General Elections.

Given that 2014 appears likely to satisfy each of these two conditions, it seems likely that the fourth sine wave of economic growth in India will begin in FY15. In specific, most opinion polls suggest that a BJP-led NDA coalition government and/or a determined PM appears likely to assume power in June 2014. Furthermore, economic reforms administered over the past two years (in the form of FDI liberalisation), an overhaul of the leadership at the RBI, compression of India’s current account deficit, partial diesel price deregulation and the creation of the fairly effective Cabinet Committee of Investments (CCI) seem likely to act as a tailwind that would aid a pick-up in economic activity once the right political leadership assumes power.

History shows that seven out of the past eight General Elections in India have been followed by strong, positive stockmarket returns (with an average Sensex return of 27% p.a. in the two-year period following the elections). Furthermore, given that this combination of economic reform and a change in the political order has typically acted as a leading indicator of the bottom of an economic growth cycle in each of the three sine waves of growth that India has experienced in the last 30 years, there is a strong case for investing into India’s fourth wave.

Investment implications

Not only India is on the cusp of its fourth economic growth wave, a wave which is being triggered by a politics and policy reset, the political reset is resulting in the central issues in the 2014 General Elections being economic management and transparency. Whilst the political battle might be between the National Democratic Alliance (NDA) vs the United Progressive Alliance (UPA), the real debate is really between Narendra Modi’s BJP and Arvind Kejriwal’s AAP. Their debate promises to define the next decade of Indian politics and hasten the demise of politically connected companies.

On the economic front, if Narendra Modi becomes PM it is likely to result in a renewed focus on a revival of the beleaguered infrastructure and banking sectors, on labour reform and agricultural reform, and on privatisation. A Modi-led government is also likely to roll back the UPA’s extensive social welfare policies. These policy moves could have major investment implications.

Over the past decade, consumption and investment in India have never moved in sync with each other and this has created macro imbalances. NDA policies have the potential to allow consumption and investment to grow in sync and this creates a new set of investment opportunities focused on companies which are at the intersection of our three mega themes, namely: (i) industrial exports, (ii) mass-scale aspirational consumption, and (iii) turnaround plays in light industrial manufacturing.

Ritika Mankar-Mukherjee & Saurabh Mukherjea

The authors are Economist and CEO (Institutional Equities) at Ambit Capital