Macroscope | Will Modi’s election setback end investors’ love of India?

Financial markets are notoriously bad at assessing and pricing political risk accurately. In the days leading up to India’s general election results, announced on Tuesday, the benchmark Nifty 50 stock market index hit a record high.

Exit polls pointed to an emphatic victory for Prime Minister Narendra Modi’s Bharatiya Janata Party (BJP) and its smaller regional allies, providing a fillip to sentiment that has been resoundingly bullish since the Covid-19 pandemic.

When it emerged that the BJP-led alliance’s victory was not only much narrower than forecast but that the BJP itself had lost its parliamentary majority, forcing it to rely on its allies to govern, stock markets plunged. The Nifty 50 fell nearly 6 per cent, its steepest daily decline in more than four years. A staggering US$386 billion was wiped off the value of Indian shares.

The shock result is a kick in the teeth for pollsters. For markets, it is a reminder that complacency can be costly. Yet, foreign institutional investors – whose bullish views were responsible for increasing India’s weighting in the benchmark MSCI Emerging Markets Index from less than 8 per cent in March 2020 to 18 per cent today – had already turned more cautious before the election, selling shares.

Last year, overseas investors bought a net US$21.7 billion worth of Indian stocks, accounting for 55 per cent of foreign purchases of equities in Asia excluding Japan, according to data from HSBC. However, this year, they have been net sellers of Indian shares. Large outflows in the past two months have reduced the ratio of foreign ownership of the country’s stock market to less than 18 per cent, its lowest level since 2012.

While several domestic and external factors are at play, the most important is that foreign investors believe “peak India” has been reached. This will make it increasingly difficult for the stock market to continue to outperform.