Even if the BJP-led government comes to power, it may not mean the start of an investment cycle, cautions Credit Suisse because only a fourth of projects are stuck with the central government; the rest are constrained by overcapacity, balance sheets, or state governments

At the cusp of elections that can transform the policy-making and administrative landscape, India's prospects are in stark contrast to the troubles in several Emerging Markets (EMs). However, don’t get your hopes too high, says Credit Suisse. Although hopes are high among investors that elections can re-start the investment cycle, it may not happen easily, feels the investment banking firm.

According to a Credit Suisse research report, there are four possibilities post the general elections. One, Narendra Modi leading the National Democratic Alliance (NDA) government with just two-three partners. Second, Modi leading the government with five-six allies. Third NDA leader other than Modi leading the government with 8-10 allies and last, the third front government with outside support from Congress. What are the economic prospects under each of these scenarios?

Opinion polls have predicted a stronger victory for the Bharatiya Janata Party (BJP)-led National Democratic Alliance (NDA), and currently put 230+ seats for the alliance.

However, Credit Suisse says, "We find the opinion polls an unreliable indicator of the upcoming election results, due to the flaws in raw data collection; insufficient sampling given the large variations in voting behaviour and subjective interpretation. However, in the absence of any better predictions, the market is likely to assume the opinion polls as indicative."

According to the research report, the performance in the immediate aftermath of election results is likely to be dependent on the electoral outcome. "Given the recent opinion poll results and the resultant market excitement, we believe the market's base case is Scenario I, i.e. 220+ seats for the NDA. This would enable the BJP to form a government with far fewer allies, possibly just two-three (272 is the number of seats needed for majority), with several other potential allies waiting in the wings for an opportunity. Such a government would be stable and strong, and excite the market, as it would allow for administrative stability and meaningful legislative action," it said.

Third front government?

According to Credit Suisse, in an extreme result, though much less likely would be if the BJP-led NDA gets less than 180 seats, which could open the possibility of a third front government or a coalition of disparate regional parties, which have no common agenda. Congress may end up supporting this government from the outside, i.e. it would not have any ministers, but would vote with the government on various issues.

"Such a scenario could potentially drive a ratings downgrade a few months later, and investors may be apprehensive of redemptions and an outflow of funds from India that cannot invest in economies rated below investment grade," Credit Suisse said.

New coalition with/without Modi as PM

Between the two extremes, where BJP-led NDA would secure more than 220 seats or less than 180 seats, there are two scenarios, as per the research report. One is a not so emphatic verdict in favour of the BJP-led NDA, driving them into uncomfortable alliances, which would constrain their reformist tendencies, at least in the eyes of the market. Within these two, the markets may be more enthused by Scenario II than Scenario III. “If the BJP-led NDA were to get less than 200 seats, the necessity of forging a coalition could potentially see a leader other than Narendra Modi becoming the Prime Minister," Credit Suisse said.

"However," it added, "we believe the market's early optimism is misplaced. Based on constituency-wise analysis of earlier election results and how strongly vote share can swing in one election shows the far more likely scenario is 190-204."

Elections won't kick-start investments

According to Credit Suisse, over the last three years, India has seen a sharp slowdown in investment. Hopes are high among investors that particular electoral verdicts can kick-start investments in a short period of time. But "even if the electoral verdict is favourable, such misplaced optimism ignores the realities of the business cycle, and overestimates the powers of the central government. Only a fourth of investment projects under implementation are stuck with the central government; the rest are constrained by overcapacity, balance sheets, or state governments," the report says.

Credit Suisse said, "Two-thirds of the projects awaiting central approval are in Power and Steel sectors, both wracked with massive overcapacity, obviating new investments. True utilisation in thermal power generation is below 60%, near 20-year lows (reported PLF is 65%). Of the litany of problems in the sector, two are crucial: state electricity board (SEB) reforms, and coal availability. The sudden stoppage of working capital loans to SEBs, risks of fuel price pass-through schemes, and stalled reduction in AT&C losses has hurt demand growth. The central government cannot revive it: state governments need to. Similarly, solutions for anaemic coal production growth i.e., restructuring Coal India and coal block auctions are likely to take several years."

Talking about challenges everywhere, the report says legal challenges are likely to stall the National Highways projects, and matter less for India's road network; Railways lacks financial muscle, and private partnership schemes are yet to take off. The government may also struggle to give a fiscal boost as the underlying stresses in government finances remain.

Going forward, Credit Suisse said, it sees three distinct phases in the Indian market. (1) the run-up to the elections, (2) the period immediately after elections (say three months), and (3) the period that ends with the calendar year 2014, where economic delivery and earnings changes will drive the market.

"Unlike a mean-reversal rally where investors jump on to stocks that had fallen the most in the prior period, the recent rally has focused on sectors benefiting from a revival in large-scale infrastructure investment. With the sectors that had outperformed thus far, i.e. IT, healthcare and staples remaining unchanged, the Indian market has been among the best performing globally in the past month," it said.

According to Credit Suisse, irrespective of which of the Scenarios plays out, the markets are likely to discover that the path of the economy hasn't changed and earnings trajectories of various sectors are unchanged. "In this phase, 'defensive' sectors like IT, healthcare and staples, and more bottom-up stories like in energy or consumer discretionary are likely to outperform, in our view," the report concludes.