CNBC's Inside India newsletter: Modi's loss could be India's gain

Indian Prime Minister Narendra Modi gestures, at the Bharatiya Janata Party (BJP) headquarters in New Delhi, India, June 4, 2024. Adnan Abidi | Reuters

This report is from this week's CNBC's "Inside India" newsletter which brings you timely, insightful news and market commentary on the emerging powerhouse and the big businesses behind its meteoric rise. Like what you see? You can subscribe here.

The big story

India changed in a day. Or at least the perception of Indian politics did earlier this week when results from the marathon six-week-long General Elections were revealed. Far from rewarding Prime Minister Narendra Modi's party with a supermajority — as polls had predicted — Indians elected 240 BJP lawmakers to India's 543-seat Parliament, which falls short of a simple majority for Modi's party. However, as the largest party, the BJP will form a coalition government thanks to its alliance with smaller parties ahead of the elections.

Without further plot twists, Modi will likely be sworn in as prime minister this weekend. However, the weakened mandate has damaged his brand. "Modi's air of invincibility is shot," said Gavekal Research's Tom Miller and Udith Sikand on Wednesday. "In future he will face political challenges not only from opposition leaders but internal party rivals as well." One needn't wait for those challenges. The dent to the BJP has been enough for speculators to float the idea — however outlandish it may be — that the opposition alliance could form a government by enticing the BJP-led alliance's smaller coalition partners over to their side. Stable coalition For Wall Street, the fact that Modi will take office for a rare third term offers stability and predictability. "Today's situation in India is different because of the strong positive impact Modi has made on the market, but at the end of the day, Modi is still in power and the market should take comfort in seeing that India's democratic election system is working," Malcolm Dorson, head of emerging markets strategy at Global X, told CNBC. Global X's parent, Mirae Asset, is one of the largest foreign asset managers in India. "Leadership continuity should trickle down to political continuity too," said Bank of America economist Aastha Gudwani in a research note to clients. "While some hard reforms may get pushed out to the middle of the tenor in a coalition, the reform agenda is still intact." India's labor laws are decades old and are said to suffer from rigidities that require serious reform. Protests by farmers in India's highly inefficient agricultural sector forced the previous government to roll back reforms within just months of enacting them. However, with a weaker mandate, analysts say there's a "low probability" that the prime minister's new administration will pick up these reforms. "That may impede growth, as Modi will find it harder to liberalize agricultural, land, and labor markets," said the Gavekal Research analysts. "But it could leave India in a more secure place socially if it dissuades the BJP from pursuing hardline Hindu nationalist policies." Dorson, who's also behind the Global X India Active ETF, agrees that "balanced government is normally seen as a market positive, as it brings a system of checks and balances." Stock market returns Moving away from the strongman politics of the past is also likely to provide other benefits for Modi, for India, and for investors. Indeed, coalitions have been profitable to investors. Data shows that are under the past four administrations, two of which were coalitions, India's Nifty 50 index rose by an average of 109% per parliament.

"The bottom line – macro stability is positive for share prices and this is the principal reason to be bullish about this election outcome," said Morgan Stanley's equity strategists led by Ridham Desai. "We expect the Sensex to deliver 12-15% compound annual returns over the next five years." Investors are likely to first see the direction Modi's new government takes when it reveals its budget in July. Will the government keep up investments that benefit infrastructure companies? Or will it increase welfare subsidies that may benefit consumer durable stocks? "The directional focus for increased capex [capital expenditure] is likely to continue, with manufacturing continuing to get policy support, in line with our economists' views," said Goldman Sachs' Pulkit Patni in a note to clients on Thursday. The Wall Street bank said railways and defense would be "key to watch" given the strong growth for these sectors over the last few years. Abhiram Eleswarapu, head of India equities at BNP Paribas, said investors may also choose to wait before making big decisions since stocks have "run up quite a bit over the last three to four years." "A lot of the good news is in the price, and therefore, investors may choose to wait for some of the announcements to translate into actual execution," Eleswarapu told CNBC's Inside India.

More on the elections

CNBC's Tanvir Gill answered the five big questions people have been asking her after Modi's weaker-than-expected election win. From New Delhi, CNBC's Sri Jegarajah reported that the prime minister will need to lean into his 25 or so alliance partners to realize his economic vision. CNBC's Sumathi Bala reported on the challenges Modi faces with cajoling smaller parties, some of whom may not share his economic or political agenda for the country. Meanwhile, CNBC's Global Markets Reporter Seema Mody reported on the concerns of some U.S. investors that have spent time and money into relationships with India. For CNBC Pro subscribers, Amala Balakrishner spoke to investors who named their 10 stock picks in the infrastructure sector, the digital economy and the startup ecosystem, as well as the consumer discretionary sector.

What happened in the markets?

Indian stocks have recovered from the 6% loss on election results day. The Nifty 50 index is heading for a 1.3% gain this week. The index has risen 5.16% this year. The benchmark 10-year Indian government bond yield has remained relatively subdued, with a yield of 7.02%, marginally higher than last week.

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On CNBC TV this week, the chief executive of privately-held Akasa Air said India’s aviation infrastructure should keep pace with aircraft orders for the next seven years. Vinay Dube added that that's not a statement he could've made five or seven years ago. Meanwhile, James Sullivan, head of Asian Pacific equity research at JPMorgan, told CNBC that India's GDP growth is not as dependent on oil consumption as before. This "radical transformation" is expected to lead to a significantly more efficient economy and help India's currency, according to Sullivan.

What's happening next week?

India's central bank will meet to set interest rates on Friday. Economists polled by Reuters expect the RBI to hold rates at 6.50%. The U.S. Federal Reserve is expected to hold rates when it meets next week.