Allies of the ruling party will likely question whether to continue the high fiscal deficit policies of recent years or to recalibrate them.
Story continues below Advertisement Remove AdSince 2021, we've seen very high fiscal deficits—around 5-6 percent—whereas earlier it was more like 3-3.5 percent.
A new government will need to decide whether to maintain these high deficits or reduce them.
The next government will need to assess if they can afford these high deficits or bring them down to around 3.5 percent.
If that happens, we’ll see a moderation in growth rates because our GDP growth has been fueled by high fiscal deficits.
Shankar Sharma, founder, GQuant Investech
Indian markets saw a sharp fall on June 4 after BJP-led NDA fell short of predicted landslide victory.
Market veteran Shankar Sharma believes nervousness to linger in markets in the short-term but remained gung-ho on India's growth story going ahead.
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Here are the edited excerpts from the media interaction:
Q. Given what's happened today, which is in stark contrast with what the exit polls predicted, do you think the markets will take some time to adjust? Or is this just a temporary phenomenon, and things will return to normal by next week?
Shankar Sharma: To be honest, I haven't followed the minute-to-minute updates because I'm in Europe and don't have live TV yet. What's the latest number you're seeing?
Q. The NDA has 289 seats, BJP 235 of those, and the India bloc has 236. But it's still a work in progress.
Shankar Sharma: So it's not final. It could still be plus or minus 20 seats either way. Assuming BJP or NDA ends up with 270-280 seats and the other side gets 230-250, it's a completely different scenario from what the markets expected. Exit polls were clearly off. Given this uncertainty, the markets will be extremely nervous for a while.
Even if the NDA forms the government, it will be a very weakened BJP, which means many expected policies might not happen. Another major issue emerging from these results is the focus on responsible fiscal discipline. Allies of the ruling party will likely question whether to continue the high fiscal deficit policies of recent years or to recalibrate them.
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Since 2021, we've seen very high fiscal deficits—around 5-6 percent—whereas earlier it was more like 3-3.5 percent. A new government will need to decide whether to maintain these high deficits or reduce them. Our bull markets in the last few years have been driven by high fiscal deficits, which create liquidity and push business growth. Stock markets prefer growth, regardless of fiscal discipline.
The next government will need to assess if they can afford these high deficits or bring them down to around 3.5 percent. If that happens, we’ll see a moderation in growth rates because our GDP growth has been fueled by high fiscal deficits. This raises many questions without clear answers at this point.
Q. In fact, I would argue the opposite. The popular narrative is that foreign investors see India positively because of macroeconomic stability and fiscal prudence, especially post-COVID.
Shankar Sharma: Fiscal prudence is a vague term. If it means low fiscal deficit, look at the numbers from 2014-2020: they were moderate, around 3.5-4 percent. Post-COVID, deficits have been 2-3 times higher. We can debate the necessity due to COVID, but running 5-6 percent deficits isn't prudent fiscal policy. It was necessary then, but going forward, these high deficits are unsustainable.
Our debt-to-GDP ratio has risen from 65 percent to about 85-90 percent in the last decade. This isn't fiscal prudence. The new government will need to reassess whether these high deficits are feasible.
Q. By saying this, aren't you undermining the India growth narrative? The narrative suggests that India offers macro stability, which is why this government is preferred.
Shankar Sharma: Pre-COVID, off-balance-sheet items were taken into the balance sheet. I'll give credit for post-COVID policies, but they can't continue indefinitely. Data shows that GDP growth was under 4 percent in 2019-20, before COVID, due to tight fiscal deficits.
COVID allowed for expanded fiscal deficits, which boosted GDP growth. Now, deficits must come down, as stated by Finance Minister Nirmala Sitharaman. Once fiscal deficits are reduced, GDP growth rates will likely moderate. This isn't about opinions; it's about data. Our GDP growth rates are directly tied to fiscal deficits. Reducing the deficit will likely lead to slower growth.
India has consistently been a strong performer in global equity markets, second only to the US in terms of 35-year returns.
Let's look at India, which has always been a shining star in the world of equity markets after the US. Over the last 35 years, India has been the number two performing market in the world in dollar terms. Foreigners have always loved India. We haven't had any sustained period of outflows from foreign investors. From 1993 onwards, they have consistently favored India. Nothing has changed from a foreign point of view.
Q. So, going forward, will the equity market performance remain strong? My sense is that we might be in for a bit of a wobbly patch, given the macroeconomic situation and the recent election outcomes. How do you see the impact of the government? You mentioned that fiscal moderation will inevitably impact GDP growth.
Shankar Sharma: I'm very clear about this. My bet is on the country, not on any party. I've been critical of and supported policies from both the Congress Party and the current government, depending on the policies themselves. India will grow irrespective of who is in power. Even past coalition governments have delivered fantastic results in terms of equity market returns, fiscal prudence, and GDP growth. There's no doomsday scenario here.
Q. Right, Shankar. Given the recent phenomenal run in the mid and small-cap markets, what advice would you give to retail investors focused on these sectors?
Shankar Sharma: Today is not the right day to think of any strategy. It's actually the worst day. Take a bit of a holiday. Markets are meant to give us earnings to take off the table and spend on things we enjoy, like holidays. Don't watch the market today; stay away for the next two or three days.
The bull market in India has been driven by small caps and, to some extent, mid-caps, while large caps have been patchy. I don't see this changing, regardless of which party comes to power. There will be a period of wobbliness, which should be seen as an opportunity. I remain very optimistic about small caps.
Q. Do you think small caps will bear the brunt of market sentiment changes in the coming months?
Shankar Sharma: Absolutely. What gives you maximum pleasure also gives you maximum pain. These stocks have provided great returns over the last two to three years, but they will also cause pain in the coming weeks. However, if you have good visibility in your portfolio, a 20-30 percent fall in an unleveraged company should be the maximum. If you have some cash reserves, this might be a good time to reinvest in strong names at a lower price.
Small caps are the future of equity markets in India. Large caps are too big for the size of the economy. Small caps, despite their volatility, are where the opportunities lie.
Q. What about large caps in the US, like the trillion-dollar companies that continue to perform well? How does that compare?
Shankar Sharma: That's a conversation for another day.
Q. But regarding FII sentiment, do you think foreign investors were waiting out the election risk and will return post-elections? Do you foresee any follow-through buying in the next few weeks? Also, what's your view on interest rates?
Shankar Sharma: On the FII side, many don't know because a lot of it involves big global tactical shifts. However, India is a significant market with a four trillion-dollar economy, and it can't be avoided. India has received a disproportionate share of FII flows in recent years, and I don't see that changing. FIIs don't come to markets like India expecting 100% policy certainty.
The experienced hands in the FII market know that India always comes through. There may be periods of volatility, but the potential for growth in India is immense. At a per capita GDP of $2,000, we know it's going to $5,000 and $10,000. So, let's chill, relax, and ignore the tape for now. It will all settle down for the betterment of the country.
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