The election results startled traders, prompting a selloff in Indian assets on Tuesday. Stocks had their worst day in four years, bond rates jumped the highest since October, and the rupee remained close to a record low. ICICI Prudential Asset Management closed a tactical bond exposure call on the 10-year government note based on the potential of a populist budget following the election results, according to a note.
"There is fear that more populist measures will be implemented, more spending will occur, fiscal consolidation will be put under strain — so all of these types of fears are emerging," said Sandeep Bagla, CEO of Trust Mutual Fund.
Strong income and a delay in spending during elections have resulted in a significant government cash buffer. Furthermore, the central bank's huge payout of $25 billion, which nearly doubled market expectations, raised optimism that the new administration would utilize some of the profits to further reduce its Rs 14.1 trillion ($169 billion) bond borrowing plans for the current year.
Benchmark rates fell below 7% to a more than two-year low before rising above that level on Tuesday. India's strong growth, as well as inflows ahead of its inclusion in JPMorgan Chase & Co's flagship emerging bond index, have boosted the market. Yields are unlikely to decrease further, according to ICICI Prudential.
Modi now needs to obtain the endorsement of two important members of his larger National Democratic Alliance, who control approximately 30 seats — enough to tip the balance of power in Parliament. Leaders of those two parties have a history of switching sides and only joined Modi a few months ago, so it's unknown whether they'll stick with him or support the opposition alliance.
According to UBS economist Tanvee Gupta Jain, the base case is that the administration would stick to a medium-term budget consolidation path with a populist bias. The higher-than-expected dividend transfer to the government will provide fiscal headroom to enhance populist expenditure to help lower-income consumption while maintaining its push to increase public capex, she said.
