“It has been said that democracy is the worst form of government, except for all the others that have been tried from time to time.”—Winston Churchill
As exit polling data becomes available for India’s current election cycle, many will surely oversimplify the results into an investment thesis. The world’s largest democracy, with about 900 million eligible citizens of voting age, is in the process of electing its 17th, lower house of parliament in seven phases over a period of about two months. The popular prediction is that a pro-business incumbent party and its allies will win with a narrow majority, based on the most recent polling surveys conducted in April by two leading media houses. A strong government will ensure sustained economic reforms, which should bode well for the economy in the long run. India’s current stock market valuations are near historic highs, predicting a return to power of a stable and business-friendly government amid high foreign portfolio inflows year to date. In an atmosphere of high expectations and a seeming near certainty of outcomes, sensible investors should ask—What can go wrong and are there any alternative narratives?
Myth #1: The incumbent is a shoo-in.
Reality: The race may be closer than most observers think.
Let’s first discuss the credibility of various polling surveys. With the exception of 1998 and 1999, when polling results were fairly accurate in their election predictions, subsequent polls for the national elections in 2004, 2009 and 2014 were all way off the mark. A lot of these surveys are conducted by media houses with clear conflicts of interest as they are dependent on political parties and governments for advertising revenues. One news channel ran a sting operation a few years ago on polling agencies and found that 11 of them were willing to manipulate the results and provide misleading results for a price. Furthermore, the methodologies of these polling surveys appear to never have been audited, debated or made public. For instance, about 70% of Indians live in villages, but most polling survey samples likely hold urban bias, leaning toward ease of execution versus accuracy of results, and many pollsters are inexperienced or ill-trained in eliciting responses from voters. To add to the complexity, many voters don’t even reveal their true intentions for fear of retribution, even though the polling agencies promise anonymity. In fact, voter turnout so far has been close to all-time high levels of 65% to 70%, which could likely be an indication of anti-incumbency. So, in a nutshell, investors cannot take the return of incumbents for granted based on polling results.
Myth #2: A win for the incumbent means the stock market can continue its rally indefinitely.
Reality: Current stock market exuberance seems disconnected from somewhat mixed macroeconomic conditions in India.
Let’s move on to the “wisdom” of stock markets. The stock market is not necessarily wise but it does represent the collective opinion of its participants, and it has been proven wrong several times in the past, especially when there is a clear disconnect between fundamentals and expectations. The most recently released earnings results have been disappointing, to say the least, across sectors. High GDP growth data has also somehow failed to translate into corporate earnings growth. In fact, this has been the case ever since India changed its methodology of calculating economic growth in 2015. The dislocations caused by demonetization and implementation of its Goods and Services Tax have manifested in weak earnings but not in weak GDP growth. What accounts for this? A recent government report suggests that 39% of the companies included in a database used to estimate India’s economic activity were closed, untraceable or misclassified. This does not mean that the GDP data is entirely wrong as the larger companies, which account for the majority of the calculations, must have been counted appropriately. This does, however, raise serious doubts over the integrity of the underlying data. The government’s delay in releasing unemployment data over the past five years has only added to the mystery. An employment survey report that was leaked to the press after the government withheld its release also suggests that India’s state of unemployment is at a record 45-year high. So, any thoughtful investor should question whether the stock market exuberance is sustainable when India is undergoing so much economic pain.
Myth 3#: Concentrated political power leads to economic growth.
Reality: A balance of power tends to be better for long-term growth.
The next assumption that should be questioned is whether a stable and strong government has necessarily been right for India. Examples of the strongest governments have been situations in which a single party commands majority, either a simple majority at over 50%, or absolute majority with two-thirds command in the lower house of the parliament. India enjoyed such governments for almost four decades following its independence in 1947, during which India’s economic growth rates were lowest and during which it fought multiple wars with its neighbors. Arguably, the lowest moment in India’s democracy came in 1975 when its then-strong government (which held an absolute majority in the lower house of parliament) declared a state of national emergency over about 21 months, and the country saw all that can go wrong with Indian democracy. An independent research group based in Sweden called the V-Dem Institute compiles a Liberal Democracy Index, which assesses whether free and fair elections exist; and whether leaders are constrained by the rule of law and oversight by parliament and the judiciary; and civil liberties are protected. The institute does a good job of summarizing India’s state of affairs in the 1970s. Unfortunately, the index shows India has become less democratic in recent years as the government led by the Bharatiya Janata Party has reduced freedom of the press related to government affairs and has restricted the range of expression. Still, India’s elections are considered generally free and fair, and the index showed a slight uptick in 2018 from 2017.
Similar to the period of “Emergency” in the mid-70s, India’s current government hastily took drastic measures, such as demonetization, without much consultation even with insiders. Even anecdotally speaking, the various institutions of governance and pillars of democracy seem to be toeing the government line—despite general perceptions that corruption is declining and reforms are occurring in some form. For example, India’s central bank has become pro-growth and more relaxed on asset quality norms since its recent change of governor. Government law enforcement agencies, which once targeted just opposition parties, have also started targeting “neutral” agencies, such as Amnesty International. Within India’s judiciary, there was also an unprecedented protest last year by its sitting Supreme Court judges who accused the chief justice of bias over assignments of high profile cases. Even the election commission has been accused recently of favoritism toward the government. Is it just a coincidence that the downfall of these institutions has concurred with the presence of a strong single-party government in power after three decades of coalition government?
In theory, an all-powerful single-party government should provide stability and execution speed. But in practice, it works well only if there is internal democracy within the party and if there is enough room for debate and dissent. Unfortunately, this is not the case in India and most parties are very hierarchical inside and revolve around personalities. The most reforms India has ever enacted were when the country was run by a coalition government in the early 1990s. The pace of reforms under a coalition government may sometimes be slow but this type of government is most likely to avoid making decisions that are too narrow in scope or too drastic in impact. It is also more likely to respect dissent and consult with various stakeholders.
Investing with a long-term view
To conclude, investing in India based on consensus expectations and without critically examining all the facts is fraught with considerable risks. As long-term investors, we focus on what is truly important, which is finding well-governed businesses that can grow sustainably in a profitable manner, and which are available at reasonable prices. We try to avoid the noise that includes forecasts around the outcome of unpredictable events such as elections. A strong government might be good for the markets in the short run, but in the long run, transparency and accountability—better-nurtured in a coalition environment—appear better able to preserve India’s democratic traditions and avoid drastic missteps that could send its economy backward. Slow and steady does win the race.
Sources: Aljizeera, Reuters, Hindustan Times, BBC.com, Economic Times, The Wire India, V-Dem Institute, The Guardian
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