Narendra Modi’s wobble in India leaves the status quo in question

To question the dominance of Narendra Modi and his Bharatiya Janata party once seemed unthinkable. But voters in the world’s largest democracy have denied the leader a third consecutive parliamentary majority.

Modi will now be reliant on his smaller partners, with horse-trading required to thrash out a government in the coming weeks. The good news for most investors is that the broader economic growth story of the past few years looks intact. But Modi-affiliated stock market darlings — such as Adani Enterprises, owned by Gautam Adani and up 7,000 per cent since 2014 — may have had their best days.

Local investors understandably hated that notion, knocking the benchmark Nifty 50 stock index down almost 6 per cent, led by Adani Ports and Adani Enterprises, which were both down one-fifth on the day.

Under Modi’s rule, the Indian stock market has flourished. It hit a fresh high on Monday on expectations of a BJP landslide and a third term for the prime minister. Indian stocks have risen more than 30 per cent over the past year versus gains of a quarter for the MSCI All-World index.

This completes a decade of global outperformance. India has also far outrun Chinese equities — flat over the decade following their post-pandemic declines.

Investors hope for policy continuity and further economic liberalisation. Modi’s vast infrastructure investment programmes in road and rail transportation, for example, should underpin India’s next five years of growth.

The private sector was already expected to pick up much of the investment tab, with government debt high at 80 per cent of gross domestic product. The country is only in the first third of a decade-long infrastructure cycle, say bulls at Bank of America.

Investor enthusiasm on this theme has pushed up equity valuations to historical highs. The Indian market, at 23 times forward earnings, trades at the top of its five-year range.

Further gains will depend on earnings growth: Nifty 50 earnings per share should grow at roughly 10 per cent annually through 2026, according to Bloomberg. Foreign inflows to stocks and bonds over the past year are at the highest levels since 2014.

The financial sector may offer an opportunity. Large private sector banks remain cheap by historical standards, says Ashmore’s Rashi Talwar. HDFC bank trades at 2.5 times book value, well below its past average of more than 3 times.

This whipsaw in Indian equities suggests that earnings need to catch up with share prices. But the transformation of the country’s economy should continue to mean growth in the medium term.

andrew.whiffin@ft.com