Congress victory provokes frenzy in Indian markets

As the first Indian prime minister in four decades to be re-elected after completing a full term, Manmohan Singh has plenty to celebrate. During his second term, he will lead a party with a strong political mandate, as the Congress-led coalition is just a few seats shy of a majority. And the prospect of a powerful, stable government has already proved good news to investors as assets across the board went skyward yesterday.

When the markets opened yesterday, the benchmark Sensex index surged to such an extent that a circuit breaker was flicked, suspending trading for two hours. Trading recommenced only for shares to continue rising at breakneck speed. When the increase reached 17.2%, markets were shut down for the rest of the day. It was the first time in the history of the Bombay Stock Exchange that trading had been suspended for the remainder of a session and the idea was to allow investors to take a cold shower.

Meanwhile, the rupee strengthened by 3% against the US dollar.

The enthusiasm stems from the fact that worries that the new government would require the support of the left-leaning parties have been quashed, creating what some India-watchers have hailed as the best possible outcome for the markets.

"The decisive result leading to a stable coalition, the removal of months of uncertainty, the concentration of power and ministries within one party leading to better co-ordination, the feel-good factor, and most enhanced status of the top leadership suggest to us that this government is better placed than most in carrying out structural reforms," said Goldman Sachs in a research note released over the weekend.

Economic activity increased after five of India's past seven elections, and this has been particularly true when the markets have considered the new government to be a stable one, the report said. Sentiment will improve in an economy set to recover in the second half of next year, predicted Goldman.

After the initial excitement wears off, the government will face a wide range of challenges. India's fiscal deficit, for example, is expected to be about 10% of GDP in fiscal 2010 (which ends in March next year), which is especially high for an emerging economy. The debt-to-GDP ratio is projected to be around 80%. One of the main challenges will be bringing these economic strains to more manageable levels.

There are a number of short-term options for the government: putting into place a goods and service tax next year could help; so too could reducing subsidies for key commodities like fertiliser and oil; and divestments could be used to retire debt.

A report by Citi is confident that the Sensex will be able to maintain gains around the 13,000 to 13,500 level (the index yesterday finished up 2,000 points at 14,272). Citi is not so surprised by yesterday's 'big-bang', but whether the electoral result is a 'game-changer' that will allow India to realise trapped potential is still unknown.

If things go according to plan, Citi thinks that companies related to infrastructure will do well, as there is plenty of room to grow as long as the right policy buttons are pressed. Banks, other financial companies, and real estate could also benefit from investment-led growth, while companies in sectors without a domestic focus, such as information technology, will be less affected.