Decoding India’s 2014 Election: The Potential for Resetting India’s Course

India is once again gearing up for the largest democratic exercise in human history later this year where 700 to 800 million voters (larger than the combined electorate of all 34 OECD countries) will select their parliamentary representatives to form India’s next government. As a result of India’s unprecedented ethnic, linguistic, religious and socio-economic diversity, this exercise is also one of the most complex elections anywhere in the world. With the popularity of the ruling Congress-led coalition declining since the 2011 anti-corruption protests and a new potential leader emerging in Narendra Modi of the BJP (India’s largest opposition party), there is intense focus in India on this election and, with four months to go, the debate has reached a fever pitch. With economic growth having slowed and key reforms all but stalled, this election is about more than which parties will form India’s government for the next few years, it is about whether India’s leaders will be able to return the country to higher growth and continue on the path of peaceful development. However, building an understanding of what could potentially happen at this important moment in India’s development requires looking not just at the current political environment but also understanding the history, wider context and key trends that are shaping the election outcome. Given the importance of this election for setting, indeed resetting, the course of India’s development, this month’s Sign unpicks the big drivers of the election outcome.

What’s At Stake?

Mahatma Gandhi, one of the founding partners of the nation, set a high bar for judging the country’s peoples, “Seven social sins: politics without principles, wealth without work, pleasure without conscience, knowledge without character, commerce without morality, science without humanity, and worship without sacrifice.”

India does not need such a high bar; Indians are getting a raw deal from their politicians on too many basic metrics. Their politicians have failed to grow the nation’s international standing, its economic growth and have allowed an estimated US$34bn to flow out of the country illicitly. India’s leaders have also failed them on a score of other measures including interest rates, inflation, income, formal employment, literacy the environment, sanitation and food. This is a mutli-decade issue not one to be laid just at the door of the existing government. Performance like this has resulted in other parts of the world in violent protest and massive civil disruption. Not so in India, thus far at least. This election comes at a pivotal time for the country given its economic growth has fallen sharply from the 9-10% range to 4-5% currently. As recently as a few years ago, economists and strategist were speaking of an emerging tri-polar world order, in which India was an emerging superpower alongside the US and China, and America wooed India as a strategic and economic partner to balance China’s rise in the region and globally. Today, with its growth stalled and its government in deadlock, the incumbent government has lost credibility domestically and internationally with India being dismissed as a “too corrupt to become a superpower” by some observers . What is at stake in these elections therefore is not just which party forms India’s government for the next few years; it is whether a leadership will emerge to put India back onto the path of high growth and development through sound economic policy and execution and also whether it will choose to tackle its deepest structural issues in order to unlock the true potential of its 1.2 billion people. If the answer is a stalemate, reforms may be deferred for a later generation and if India is not able to do this within the next five years, it will cement its position as one of a number of structurally challenged and volatile developing countries. However, if India can successfully seize on this moment of political transition, then the country may get back on the path that was once predicted – becoming both a key driver of global growth and an economic and political superpower.

A resurgent India has the potential to be a more peaceful, secure and prosperous nation providing economic opportunities to its citizens; and also be a symbol of hope for other developing countries as an economically strong and functioning participatory democracy. In this context, this election is about far more than the personality politics and anti-incumbency mood which currently seem to be the dominant theme being reported in the media. The indications are that a deep political change is already underway in India. The winner of this election faces a highly expectant citizenry that has placed their confidence in the democratic system and now want the benefits. The winner will need to deliver the vision, the skills to unite the country and, failing that, the realpolitik acumen to overcome determined obstacles to put the country on a course that quickly recoups its lost momentum.

To understand the deeper change that is already in play requires one to take a look at how India’s politics got to this stage. This provides the context for identifying the key dynamics in the current election, the strategies and tactics being employed, as well as the current state of play in the key battlegrounds. This will expose the potential outcomes of the election and the likely impact on the markets, which is of relevance to investors and India’s future political leaders since the nation requires a substantial inflow of foreign capital to move to a higher growth trajectory. In the long-term, for the markets, this election remains about whether the incoming leadership can successfully accelerate India’s growth from the 6% levels which it is currently expected to recover to by next year, to double digits. Upcoming issues of the Sign will explore the policy initiatives that may rapidly put India back on the path of broad-based high growth.

How It Got to This Stage: The Decline of Congress and the Rise of a Multi-Party Democracy

The Indian National Congress (popularly known as Congress) is the leader of the United Progressive Alliance (UPA), which has led India for the last decade with outside support from regional parties. The UPA, and more importantly, Congress is facing strong anti-incumbency throughout much of the country, mainly as a result of the economic slowdown and multiple large-scale corruption scandals which together have shaken the electorate’s basic faith in the effectiveness of its government. This is not merely anti-incumbency; it is a new phenomenon in Indian politics. Having governed, or as one could say “ruled”, India for 55 of its 66 years as an independent nation, Congress’ proposition no longer seems to reflect the changing profile of India’s electorate; which is ironically a by-product of the growth unleashed by Congress’ own reforms when it was in power from 1991 until 1996, and under the first UPA government.

For the first four decades of India’s independence, Congress was the dominant national party in India. However, as India’s electorate grew and evolved, its allegiances to its founding fathers and Congress were gradually eroded. As a result, over the past 25 year, the political landscape has transformed from being dominated by one party to becoming a much wider contest. During this time, Congress has ceded its near monopoly on power, a rival national “Congress’ proposition no longer seems to reflect the changing profile of India’s electorate; which is ironically a by-product of the growth unleashed by Congress’ own reforms when it was in power in an earlier era”party has emerged (the “BJP”) and India’s politics has fractured in favour of regional interests. In addition, the neglected states of Bihar, Madhya Pradesh, Rajasthan, and Uttar Pradesh (collectively referred to as “BIMARU”), the poorest parts of the country, have seen strong state leaders emerge to challenge Congress while the key states of Tamil Nadu, Orissa, West Bengal were lost to regional interests long ago with states such as Andhra Pradesh and Maharashtra becoming the new bastions for regional parties. This has shifted India’s political paradigm to a coalition-based governance structure, in which no one party is able to govern without a meaningful number of allies or outside support from these key states. The initially shaky coalitions of the 1990s, however, seem to have given way to relatively more stable coalitions under the leadership of the national parties. Regional parties who have come to power in various states have in turn risen to prominence at the national level by cornering a ‘catchment’ of parliamentary seats to effectively enhance their bargaining power with whichever government is in power.

Single-party rule has therefore given way to a landscape with the two national parties trying to consolidate their bases while fighting various regional battles and bargaining with a large constituency of regional and other interests who serve as the kingmakers.

The Dynamics of the Current Election

With regard to the current elections, the current government’s apparent lack of empathy and tangible response to successive waves of nationwide urban middle class protests since 2011 – initially against corruption, and subsequently over law enforcement, women’s rights and security and other everyday issues – combined with slowing growth and high inflation, has further reinforced the prevailing belief that a Congress-led coalition may not return to power. There is also a transition ongoing within the Congress party with a new, younger leadership taking charge but with insufficient time to establish their credibility given the impending election. In the emerging political vacuum, an opportunity has arisen for new voices to emerge to define a new vision for the country and with the help of regional parties provide an alternative to the current government. For voters, three alternatives to the status quo (represented by the Congress) have emerged:

1. The Opposition Reinvented.

The National Democratic Alliance (currently 137 seats or 25% of parliament), led by the BJP (Bharatiya Janata Party meaning the Indian People’s Party), has found a new leader in Narendra Modi, the increasingly popular (sentiments tend to be extremely divided too) and widely thought to be charismatic Chief Minister of Gujarat, who has very effectively stepped in to exploit the anti-Congress sentiment and fill the desire for robust leadership called for by a large section of the electorate. The BJP, which emerged as the principal opposition to Congress in the 1990s, has developed a strong array of regional leaders over the last decade in India’s northern and western states of which Gujarat, under Mr. Modi’s leadership, is the best example of delivering economic growth. Gujarat has delivered China-style growth of 10% per annum on average under his leadership with strong industrial development, robust infrastructure, and has also emerged as one of the most business-friendly states in India with a reputation for having addressed corruption and excessive bureaucracy. However, the BJP had also become an “incumbent” opposition party with an ‘old guard’ of national leaders who, similar to Congress’ old guard, could not articulate an inspiring national vision. Mr. Modi effectively challenged this guard in 2013 and emerged as the BJP’s Prime Ministerial candidate despite a public display of internal rivalry. He has used the example of Gujarat’s success, as well as the success of other BJP chief ministers in neighbouring states, to strengthen his credentials to lead the country and developed a seemingly-effective strategy to promote himself as a clear alternative to Congress and to Rahul Gandhi - the next generation of the Gandhi dynasty to lead the incumbent party - and has thereby increased his support beyond the traditional BJP voter base.

2. The Regional Powerhouses.

Regional parties, particularly across eastern and southern India have consolidated their positions in their states, marginalising the national parties and today collectively represent one of the biggest “blocks” in parliament with 181 seats (33% of total). Increasingly, it is these state leaders who hold the keys to power as they leverage their positions to extract key cabinet positions and concessions for their states which in turn help them strengthen their support base. Some regional parties, while not aligned to one of the national parties per se, are ideologically diametrically opposed to one of the two and are therefore predictable in terms of parliamentary voting patterns. However, the bulk of regional parties, collectively almost as large as the opposition, are “free radicals” – who at various times over the last five years have been allied with the ruling government or the opposition or neither. The influence of this group has been further strengthened by their performance in various state assembly elections since the last general election, which will allow them to further increase their leverage in the next central government.

3. The Peaceful Revolution.

Much more recently, specifically since the nationwide anti-corruption protest of 2011, India’s rapidly growing urban middle class has had a political awakening manifesting in large-scale street protests against graft, government inaction and personal injustice. This movement has also found an explicitly political voice in the AAP (Aam Aadmi Party which translates as the common man’s party) which recently surprised many observers by winning 40% of the seats in the Delhi state assembly and forming the government with support from the few remaining Congress representatives. Seizing the capital, Delhi, has been a strategic and spectacular debut for the party which could potentially offer a clear alternative to the large block of urban voters who are disaffected with the overall level of mis-governance in the country and wary of both the national parties. While the AAP’s ability to govern in Delhi and organise itself on a national level is yet to be proven, it has the potential to establish itself as an important and disruptive force in both the current and future elections.

Finally, the context for the rise of all three of these alternatives is the changed profile of the Indian voter. There will be up to 150 million first time voters in this election, representing as much as 20% of the total electorate. 

More importantly, economic liberalisation has changed the profile of the electorate – which is significantly younger, more urbanised, better off, and more connected than it was in 2004 when Congress came to power (see inset). Recent state assembly elections have seen elevated turnout levels as this electorate is more restless for jobs and growth, along with transparent and effective governance than ever before. After a long time, the feeling in India is that politics and governance can make a difference. Indeed, the experience of 8-10% growth followed by a period of 4-5% growth and rising inflation has made voters believe that the “right” kind of leaders governing the country can materially impact their daily lives. This new trend is juxtaposed with the historical practice where many of India’s actual ground-level electoral battles have been fought along the lines of caste, religion, and historical allegiances. While this changing profile is clearly having an impact in driving anti-incumbency, it is unclear whether this will translate into votes and thereby drive a change in focus on the part of India’s leadership after the elections.

The major factors which will drive the election result are therefore well-set. The key question for the incumbent Congress is whether it can change the narrative from anti-incumbency to a vision which can challenge that presented by its main rivals, in particular Mr. Modi. The BJP’s fundamental challenge, having made gains across the north and west (see Battlegrounds) is to find ways to extend its influence into the other regions. The AAP and the regional parties now must translate their success in state elections into seats in the national parliament, and decide which of the national formations, if any, they will want to partner with in order to maximize their leverage in the next government.

India’s politicians have been caricatured as a group holding the view that once they had won an election, the country and its assets were theirs to do with as they wished in the recognition that accountability would be an impotent force. In turn, the public have been caricatured as seeing the politician as an imposed nuisance to be bargained with or best avoided if possible. This has clearly changed and this election and its build up represent the turning point. What is “What do all men with power want? More power.” The Oracle, The Matrix Reloaded (Directed by The Wachowski Brothers, Produced by Joel Silver, Studios Village Roadshow Pictures, Silver Pictures) clear from the last two years of successive protests is that no government – whether Congress or BJP– will be able to afford failure to deliver on the high expectations of ordinary Indians without risking the wrath of a much more activist young and urbanised electorate. This message is of course the message of the Arab Spring and in India is being played out through India’s electoral system rather than civil violence. It remains to be seen whether India’s politicians heed the message and deliver on the confidence that the people have shown in the system.

Strategies and Tactics: The Fight to Define the Narrative

India, like many other countries, has seen its fair share of identity and personality-based politics. As BR Ambedkar, the author of India’s constitution had remarked, “In India, Bhakti or what may be called the path of devotion or hero-worship, plays a part in politics unequalled in magnitude by the part it plays in the politics of any other country in the world.” This remark holds true for the current elections as well, with all the leading parties forming campaigns around visible personalities and currently seeking to disparage each other’s credibility.

Mr. Modi, seeking to exploit the strong anti-Congress sentiment throughout the country, has seized the opportunity to project himself as an alternative to Congress. Mr. Modi has often used a slogan of “Congress-Mukht Bharat” or ‘Congress-free India’ at his rallies which have vilified the Gandhi family, with the apparent objective of undermining the credibility of the Congress leadership and tying the current state of affairs in India to the decades which the Gandhi family has spent ruling the country. This strategy is reported to have served as an effective tool in drawing certain voters to Mr. Modi. The Congress also seems to sense its own weak position and appears to be following a cautious strategy which some media observers have dubbed “Anyone But Modi”. To deflect from the dynastic charge and perhaps in recognition of the difficulty of fighting the Modi campaign at this time, Congress has chosen not to project Rahul Gandhi as its Prime Ministerial candidate (by citing tradition) for now. However its actual strategy appears to be to corner as many allies as possible by invoking a fear of Mr. Modi as beholden to Hindu nationalist groups and as an autocrat who will polarise the country along religious lines. Repeatedly invoking Mr Modi’s past, including the 2002 Gujarat riots and deaths which took place during his administration appears to be Congress’ central strategy in appealing to voters and potential allies. However, this strategy has been somewhat undermined by the failure to convict Mr. Modi or his government (including a Supreme Court’s ruling which failed to establish an offence regarding Mr. Modi or others named in the investigation) as well as the Congress’ own involvement in the 1984 anti-Sikh riots and deaths (following Indira Gandhi’s assassination) which have been invoked by its opponents to neutralise these allegations.

Congress has tried to fight anti-incumbency by highlighting the positive elements of its track record over the past decade including the heady days of 8-10% growth in 2004-2009 and the recent acceleration in agricultural growth and rural incomes (largely due to a strong monsoon season, but also driven by Congress’ various rural welfare schemes). However, given the overall growth having slowed so precipitously, the rupee having collapsed against the dollar and inflation still high, and with the macroeconomic situation unlikely to change materially for the better before the election, this strategy may well fail to impress the electorate. It is also difficult for the party to be given much credit for the structural reforms under its tenure (such as the Right to Information and Right to Education acts) when its integrity is under question because of the corruption scandals in which stalled private investment and infrastructure projects linked to crony capitalism type deals have led most to question its long-term capability to govern.

The AAP, until now effectively an anti-establishment party, having recently taken charge of the Delhi government, is on a crash course to learn how to cope with the responsibilities of power. The media spotlight has rapidly shifted from AAP’s surprising electoral success to its ability to govern. The party’s leader, Arvind Kejriwal, has emerged as the face of the movement and initially won support from young urban voters by showing a self-effacing public persona – taking the metro to his inauguration and in one instance even sleeping on the streets in protest against lack of action by the Delhi police. However, while this humility is certainly attracting the affection of the “common man,” such actions are being dismissed by a harsh press as mere symbolism and are leading its opponents to paint the AAP as an “anarchist” or “populist” party which only knows how to protest but not how to govern.

Given the intensity of these battles for position, the next few months may well disintegrate into a mud-slinging match highlighting the personal failures of both the incumbents and the challengers. If so, the game will quickly become a battle of personalities rather than the ideas for change that the country needs. However, AAP was born from protest and its victory in the Delhi elections clearly demonstrates that there is a growing desire in India for a government which can stand for higher values and offers to put its head down and focus on the hard work of addressing the issues “It might be too optimistic to say that to win this election, the parties will need to shift to ideas-led politics which elevate the country’s political discourse to the levels required for progress and development, but the signs are that this is the will of the people.”and trying to create opportunity for the populace at large. This is a promising check on the collapse of the electoral campaigns into character assassination which, if successful, will force the major players to develop a clear narrative to how they intend to unlock India’s potential. It might be too optimistic to say that to win this election, the parties will need to shift to ideas-led politics which elevate the country’s political discourse to the levels required for progress and development, but the signs are that this is the will of the people. And if so, both major parties will need to do what they have avoided thus far, namely, unveil a meaningful and specific plan about how they intend to set the nation on the course of achieving its economic potential. In the coming weeks the battle will move to the constituency level and will provide an opportunity for any of the players to shift the narrative in their favour. If a week is a long time in politics, there are still ten weeks or so to go before India heads to the polls and another 14 weeks until the results are announced.

The Current State of Play, Key Battlegrounds and Potential Post-Election Scenarios

On the success of incumbents and how it can work against further success, Karl Rove, Senior Advisor and Deputy Chief of Staff during the George W. Bush administration and the US Republican party (popularly called the “Grand Old Party”) strategist, cautioned “The GOP's progress during the last four decades is a stunning political achievement. But it is also a cautionary tale of what happens to a dominant party … when its thinking becomes ossified; when its energy begins to drain; when an entitlement mentality takes over; and when political power becomes an end in itself rather than a mean to achieve the common goal. ”

The outcome of the election is not yet clear not only because of the dramatic rise of new players such as AAP but also because Congress may well play out some very unexpected cards.

I) The Current State of Play.

In the 2014 general election, an estimated 725 registered voters , divided into 543 parliamentary constituencies (or “seats”) will vote one Member of Parliament from each constituency. The party or coalition of parties that crosses a simple majority (i.e. 272 seats) will have the opportunity to form the government. India’s political landscape can be divided between the Congress-led United Progressive Alliance (UPA), the BJP-led National Democratic Alliance (NDA), with the remainder being comprised of regional parties (including the Free Radicals), a coalition of Communist parties active in pockets across India’s east and south, and independents. The latest opinion polls and seat forecasts from CNN-IBN last month show the UPA declining from 225 to 107-127 seats – with the Congress dropping to its lowest tally ever. The NDA is expected to make significant gains increasing from 137 to 211-231 seats – driven largely by the BJP’s gains in the northern and western regions of India (see chart).

II) The Key Battlegrounds.

The key battlegrounds of the elections are one level lower, at the state level. There are 28 states (and seven ‘union territories’) in India across which the 543 parliamentary seats are divided. The six largest states currently account for 291 or a majority of seats in parliament. More importantly, five of these states are ruled by “Free Radicals” while the remaining one has strong two strong local parties which have emerged. As a result, many of these states have three or four major parties contesting – which in India’s “first-past-the-post” electoral system – means that whichever party gets the most votes in that constituency wins that seat (even if that vote percentage is low in absolute terms).

Where is the BJP Gaining? Of the gains expected by the NDA, there is a clear shift visible in India’s northern states where it is expected to gain c.72 seats – of which almost half are from one state (Uttar Pradesh). It is also expected to gain c.13 seats across four large eastern and southern states, primarily through its coalition partners. In the key states of Maharashtra and Karnataka (home to Mumbai and Bangalore respectively), the BJP and its ally the Shiv Sena are expected to pick up c.9 seats while losing 11 seats in Karnataka.

III) Potential Post-Election Scenarios. Based on these latest polls (which it should be noted have sometimes proved to be poor predictor of results in the past), we can see three potential scenarios for the formation of the next government

a. NDA Government: If the BJP-led NDA performs as per the poll expectations, it will still be c.50 seats short of a parliamentary majority and would therefore need to enlist outside support from at least two to four regional parties in order to form a government. The challenge for the BJP will be in securing these allies without compromising its agenda and alienating its core supporters. Of course, if the NDA ends up with more seats than indicated in the current polls (e.g. by not losing the 11 seats forecast to be lost in Karnataka or getting more than 35 incremental seats in Uttar Pradesh), then Mr. Modi’s leverage with allies and his ability to enlist their support will be that much higher.

b. UPA plus Free Radicals Government: On the other hand, it is also conceivable that the UPA along with several regional parties beat the forecasts and are able to collectively win 190-200 seats (vs. the 140-180 seats currently being projected in the opinion polls) by posting better numbers in UP and Maharashtra. This may allow the UPA to stitch together a governing coalition with support from several Free Radicals or provide outside support to a coalition of Free Radical parties (like it did in 1996). However, any such coalition would invariably be comprised of numerous powerful state leaders demanding significant concessions from Congress and each other, and would therefore be inherently unstable given the various interests involved and likely require a strong leader at the helm in order to last its full term. It is unclear who that is in the Congress party today.

c. NDA Government with a “Compromise PM”. Another variation that is possible is one where the BJP is the single largest party but still not able to convert the numbers currently being projected for it – either due to a loss of seats to the AAP in key urban constituencies or to regional parties in the south or the north and west. In this scenario, if the BJP is unable to muster enough allies, Mr. Modi may not have the ability to claim a victory and consequently the Prime Minister’s role, therefore it may be possible that the BJP or the NDA may need to identify a different leader who can build a coalition with regional parties that have deliberately moved away from Mr. Modi.

A number of strategies, if played out well, have the potential to change the prevailing view of who wins and who loses. A few of these should suffice to illustrate the Machiavellian or, more appropriately for India, Chanakya-ian , nature of the game that can yet play out in India’s election.

Games That May Yet Change the Outcome

1. Let the Kite Soar High and Then Cut the String. This requires Congress to continue to allow Mr Modi to play out his hand as the clean hand of politics and then for Congress to provide compelling evidence to the contrary, should such evidence exist.

2. Change the Face to Woo the Admirer. Congress could effectively build a coalition with AAP and other regional parties to form a government and perhaps even offer the prime minister’s post to one of them. Then having defeated the BJP, bide its time, rebuild its support, hobble the prime minister and topple the country into another election at the opportune moment.

3. Turn Failure to Win Outright into Disaster and Wait to Win Greater. If the BJP fails to win decisively, they could let Congress form a government of ever more disparate and unruly partners with a view to their failure triggering a highly disgruntled electorate ready to give the BJP a decisive victory in a hastily called new election.

4. Unite the Free Radicals. A number of the regional parties could form a united “front” of super-coalitions as they often have in the past. What is unique this year is that, with their increased strength, a large enough block of these could in fact make it impossible for either BJP or Congress to come to power without their support, and then they could stake their own claim.

In the playing out of such games, the electorate and their needs may well be forgotten. The next three months will tell which path India heads down and the credibility of the outcome in positioning India to take its place among world powers and economies.

Impact on India: Market Scenarios

Clearly, this change in government is one that India investors have been waiting for to take a view of India’s attractiveness. The impact of the upcoming elections on the markets can be divided into two phases:

1. Reflex Reaction: Short-Term Phase. This is the “immediate” reaction of the markets to the results of the elections, exemplified by the day one move and possibly lasting up to 90 days. In India’s case, there is a nascent bond market and an active equities market; and hence it is the change in the stock market which commentators see as sign of the “market’s verdict on the elections”. Foreign investors dominate trading volumes in the equities market. As such, the short term impact on the market will likely be a function of what foreign investors believe the incoming government is capable of and in particular, whether the recent trend of low growth, high inflation and weak governance will be reversed.

2. Measured Reaction: Medium to Long-Term Phase. This is the reaction of the markets not to the election results; but to the actions (of omission or commission) taken by the elected government in its first few months and over the first 18 months. Within the first few months, the stability of the government, its performance vs. expectations and the impact of its policies on the business environment starts to become clear. As such, the market reaction in this phase is a function more of the actual policies and governance outcomes than a hypothesis about the likely performance of the new government. The first 18 months will demonstrate whether the government has a string of policies and an effective way of navigating opposition or whether their intent has been hijacked by the realities of the Indian political system.

Past elections indicate that market valuation multiples typically ‘re-rate’ in the medium term (i.e. within one year of the election). The direction, up or down, seems to be linked to two key factors – (i) the stability of the winning coalition and the decisiveness of the election mandate (i.e. how comfortable a parliamentary majority has been secured); and (ii) the investors’ perception of the winner’s credentials in delivering reform and economic growth. For example, in 1999 and 2009, when stable reform-oriented coalitions under the BJP and the Congress came to power, the market multiples for large caps increased by 66% and 25% respectively one year after the elections (for mid caps, which are a good indication of the strength of commitment since they are less liquid than the large caps this was 50% in 2009 ). In contrast, the 2004 election which saw a weak Congress-led coalition come to power (with only 145 seats and reliant on outside support from the Left front), multiples for large caps declined c.7% one year after elections while mid-cap multiples declined by 10% over the same period (see chart).

Based on this we can construct upside and downside near-term market scenarios which should define the boundaries of the Indian markets in the year following elections:

I) “Bull Case”, Decisive Mandate: Markets rise 30% to 50%. In a scenario where either of the two national parties are able to win c.180-200 seats and form a government with relatively little outside support from regional parties, we calculate that valuation multiples for large caps and mid-caps could increase by up to 25% and 40% respectively. Based on the consensus earnings projections, this implies potential upside of 30% and 53% from current levels for large caps and mid-caps, respectively, by December 2014.

II) “Bear Case”, Fractured Mandate: Markets fall 2% to 4%. Conversely, in a scenario where neither of the national parties is able to win c.160-180 seats and the government is formed with significant outside support (requiring power sharing compromises with the regional parties), we calculate that large cap multiples could decline by 7% while mid-cap multiples (which have not increased in the recent rally) would decline by 10%. However, due to the fact that the market is already trading at an approximately 30% discount to its long-term average, even with a further decline in multiples, projected earnings growth alone would contain the fall to 4% for large caps and 2% for mid-caps.

The charts below reflect the potential upside and downside in the 12 months following the election from current levels for both the large cap and mid cap indices based on the scenarios outlined above:

In addition to the strength of the mandate, the near-term market reaction is also of course shaped by investors’ perception of the winner’s credentials in delivering reform and accelerating growth. Therefore, a “growth-friendly” government typically sees a higher premium than the alternative. In the current context, it is clear from the commentary in recent research from leading foreign brokerages (see excerpts below), that the Modi-led BJP is seen as far more market-friendly than the incumbents. The recent rally in Indian equities, driven in part by the increased likelihood of a decisive mandate for a BJP-led government under Mr. Modi (reflected in the opinion polls), can also be seen in this context with the initial re-rating already underway. Since August, the market has rallied 15% but as the analysis above shows, there is significant upside potential from current levels.

The nuance in this election seems to be that the short-term reaction to a decisive BJP win may be higher than the short-term reaction to a decisive Congress win. This is most probably a reaction to the last few years’ performance of Congress but also reflects the expectation that a Modi-led BJP government will make a break from the recent trend and create a more robust governance model and have the energy to introduce real change to tackle the performance issues of the country. If a Congress-led government returns to power, even in a decisive victory, it is not clear that they will get the “benefit of the doubt” by foreign investors who have experienced a relatively tough last few years under the same government. There may be a feeling that the Congress-led government will not be able to do anything much different from what it has already been doing (recognising that it had a pretty decisive mandate from 2009-2014 as well). Congress, if it were to secure the mandate, can take heart that what happens after the first few months will be determined by how the government in power conducts its policies and delivers outcomes.

Looked at it from that lens, a Congress-led government, beginning with low expectations has the potential to deliver high outperformance outcome in the medium to long term if it is able to renew its energy to take decisive actions that change the economic trajectory of the country (something it managed to do in the 2004-2009 period). However, this requires it to break from its most recent track record.

A BJP-led government may get a brief “honeymoon” period with investors – foreign investors in particular may well come back to the market – but it has high expectations to live up to. To match up to these high expectations, the leaders of the party will have to come to the table pre-prepared with their action plans and start showing tangible results early to capitalise on the potential positive momentum that may greet them.

Conclusion: India at the Juncture, Ready for Change

India is today a vibrant democracy of diverse visions and voices. It is tempting for frustrated observers, inside and outside the country, to talk about the democratic penalty. As the analysis of the correlation between freedom and economic performance demonstrates very clearly, this penalty is clearly not about democracy but about leadership .

While the increased awakening of people to their fundamental right “Choice is an illusion, created between those with power, and those without it.” The Oracle, The Matrix Reloaded (Directed by The Wachowski Brothers, Produced by Joel Silver, Studios Village Roadshow Pictures, Silver Pictures) to opportunity has led to bloody uprisings in so many corners of the world, the Indian population thus far has demonstrated a highly mature adherence to the exercise of their right to protest and the process of democracy. So, coming from a position where India has been de-railed from its development path, this election is a test of the ability of the democratic process to deliver a government that can provide opportunity to the people. As the illustrated strategies show, both national parties still have a chance of securing victory; the key question is whether the winning coalition will be able to return India to a path of double digit growth. While improving macro fundamentals (unlikely to be disturbed as a result of the election) will allow India to recover to about 6% growth by next year, moving back to a higher growth trajectory which can meaningfully reduce poverty will require concerted action.

Enormous courage, and much else, will be required to unlock the potential of India. A previous Sign looked at the enormous challenge and imperative for making India Wide Open to foreign investment and talent. Driving such changes will require vision, perseverance and no doubt some cunning given the stalemate nature of Indian coalition politics when it comes to tackling sensitive big issues. As is evident from this analysis of the potential election outcomes, any government is likely to be reliant on outside support from regional parties in order to govern, making it entirely conceivable that a government which fails to live up to expectations will not be able to last its full term. The best, and perhaps only, way to ensure a stable government (as well as increase its political support in the event of early elections) will be for the winning party to come out of the gates running, rapidly implementing a focused reform program to accelerate India’s growth from the current to double digits within two to three of the first five year term . Needless to say, failing to deliver the changes required to put India back on its growth trajectory is a tragedy for over 1.2 billion people who will by April-May 2014 have patiently placed their faith in democracy.


  1.  Source: Financial Times, July 2011 (
  2. Source: Reserve Bank of India, Gross State Domestic Product database
  3. The term “free radical” is based on an electoral analysis by the polling firm CVoter from Jun-2013 (
  4. Source: The Grammar of Anarchy, speech by B.R. Ambedkar to the Constituent Assembly of India (the body which drafted the country’s constitution after independence), November 1949 (available at
  5.  The exact dates for the election will be announced in late-February.  Media reports indicate that the Election Commission of India will hold the election in four-six phases over a month starting approximately in mid-April
  6. The entire quote from Karl Rove was equally about any incumbent – not just the GOP, but the Democrats as well – and reads as follows: “The GOP’s progress during the last four decades is a stunning political achievement. But it is also a cautionary tale of what happens to a dominant party – in this case, the Democrat Party –  when its thinking becomes ossified; when its energy begins to drain; when an entitlement mentality takes over; and when political power becomes an end in itself rather than a mean to achieve the common goal,”
  7. Figure from Indian Election Commission; not updated for most recent registrations
  8. Chanakya  (c. 370–283 BCE) was an Indian teacher, philosopher, and royal advisor and is widely credited with having played a key role in the success of the Maurya Empire
  9. The CNN-IBN and CSDS election survey presents a range of seats for each party by state based on expected conversion of votes into parliamentary seats; for the purposes of our analysis, we have considered only the mid-point of the range
  10. The CNN-IBN and CSDS election survey presents a range of seats for each party by state based on expected conversion of votes into parliamentary seats; for the purposes of our analysis, we have considered only the mid-point of the range
  11. Data on P/E multiples for mid-cap is not publicly available for the 1999 election
  12. Upside and downside valuation scenarios are based on consensus earnings growth projections for large caps and mid-caps over the next year.  For the Bull Case, we have assumed an upward re-rating of the market multiple in line with previous elections where stable coalitions came to power (e.g. 1999 and 2009 election).  Our Bear Case assumes a decline in valuation multiples in line with the de-rating seen in elections which saw comparatively weaker coalitions dependent on significant outside support come to power (e.g. 2004)
  13. See the April 2012 Sign of the Times “China and the Freedom Advantage”
  14. See the February 2012 Sign of the Times “India Wide Open”
  15. A further pre-election issue of the Sign will explore in greater detail the action plan and steps the incoming government will need to implement in order to achieve this.
  16. ©2014 Greater Pacific Capital