INDIA DAILY October 25, 2013 India 24-Oct -day 1-mo 3-mo Sensex 20,725 (0.2) 4.4 4.6 Nifty 6,164 (0.2) 4.9 4.3 Contents Global/Regional indices Special Reports Dow Jones 15,509 0.6 1.5 (0.3) Nasdaq Composite 3,929 0.6 4.5 9.0 Strategy FTSE 6,713 0.6 2.5 1.9 Strategy: Party time or no party time? Nikkei 14,345 (1.0) (1.9) (1.5) Hang Seng 22,762 (0.3) (1.9) 3.9 Daily Alerts KOSPI 2,032 (0.7) 1.7 6.4 Results Value traded – India Cash (NSE+BSE) 140 131 139 IDEA: Marginally below expectations; voice volumes disappoint Derivatives (NSE) 2,051 2,309 2,450 UPL: Gaining out of depreciating currency Deri. open interest 1,583 1,680 1,607 Results, Change in Reco NMDC: Downgrade a notch after recent rally Forex/money market Change, basis points Sector 24-Oct 1-day 1-mo 3-mo Banks/Financial Institutions: Dilute and dilution Rs/US$ 61.5 3 (77) 254 10yr govt bond, % 9.0 2 (3) 49 Technology: Building up steam Net investment (US$mn) 23-Oct MTD CYTD FIIs 105 1,891 15,293 MFs (16) (410) (3,333) Top movers Change, % Best performers 24-Oct 1-day 1-mo 3-mo JSTL IN Equity 846.3 0.7 11.7 49.3 TATA IN Equity 332.2 (0.9) 14.1 49.0 GMRI IN Equity 22.8 1.3 4.8 44.9 SSLT IN Equity 198.8 0.1 5.3 42.1 SAIL IN Equity 61.3 0.1 17.4 41.2 Worst performers FTECH IN Equity 154.6 (5.7) 3.1 (75.2) EDSL IN Equity 23.3 (0.6) 22.3 (23.7) PNB IN Equity 494.7 (0.2) 2.0 (20.9) SHTF IN Equity 549.5 (0.5) (5.3) (16.8) UNBK IN Equity 122.7 2.1 6.4 (15.5) For Private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES’ RATING SYSTEM AND OTHER DISCLOSURES. REFER TO THE END OF THIS MATERIAL. Strategy.dot INDIA Strategy OCTOBER 25, 2013 NEW RELEASE BSE-30: 20,725 Party time or no party time? As India gears up for its next national elections (April- May 2014), we examine the contours of the Indian political landscape and conclude that the outcome of the 2014 national elections is quite uncertain. Political uncertainty notwithstanding, we believe India will continue for some more time with its confusing and contradictory mix of (1) gradual privatization of the economy and (2) entitlement politics. This will change for the better over the next decade as the Indian political system will have to adapt to a new economic reality. The 2014 national elections—a difficult one to call (1) Massive fragmentation in most large states, (2) a large number of first-time eligible voters (120 mn); actual registrations may be lower and (3) likely higher turnout make it hard to predict the outcome of the next national elections. A simple analysis of 2009 national election results shows that 236 constituencies (out of 543 for election to Lok Sabha) had a less than 6% gap between the vote shares of the winner and the runner-up. Thus, a vote swing of -3-+3% could have affected the outcome of the 2009 national elections significantly. We build a detailed constituency-wise model for ‘forecasting’ the 2014 national elections but refrain from publishing the results of our proprietary model for obvious reasons. Too early to position portfolio for elections; good companies will always do better, anyway It is too early to construct a ‘pre-election’ portfolio (there are other variables between now and April 2014). Also, assigning probability to outcomes and designing corresponding portfolios may be meaningless since only one of the several ex ante scenarios will play out. We recommend investors stick to good companies in light of the large uncertainty. The outcome of four important state elections in November-December 2013 may provide more clarity. Entitlements, social identity, economic development key focus areas; next decade to be better We expect entitlements, social identity and economic development (in that order of priority) to be the key focus areas in the 2014 national elections. However, we expect economic development to emerge as a key electoral issue over the next decade as India’s demographic profile changes meaningfully (more people in the working-age population). The demographic changes and a high proportion of middle-income and high-income households will force the political class to focus on economic development as the central election issue and concurrently reduce focus on the usual factors that currently drive Indian politics. The Indian political system has failed to galvanize the Indian economy so far; time for a rethink In our view, the Indian political system, with its obsession with socialism and entitlement politics, has failed to provide sufficient impetus to the Indian economy. Over the past 3-4 decades, the gap between India and its regional peers has increased dramatically. The Indian political class still believes in ‘big government’ to channelize resources and manage the economy though this is changing through creeping privatization in several areas. For private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES’ RATING SYSTEM AND OTHER DISCLOSURES, REFER TO THE END OF THIS MATERIAL. Strategy India OVERVIEW: THE OLD VERSUS THE NEW Indian voters will face a confusing babble of choices in the form of various political parties vying for their votes offering (1) economic development, (2) entitlements, or (3) more likely, a ‘heady’ mix of the two. A large number of new voters, low visibility on pre-poll alliances and large fragmentation of voters and parties preclude any confident predictions of the outcome of the 2014 national elections. 2014 national elections—the outcome is highly uncertain (1) Massive fragmentation among political parties and voters in most large states, (2) 120 mn first-time voters; actual registrations may be lower, (3) likely high turnout, (4) no visibility on pre-poll alliances for major national parties and (5) high-decibel campaigns on new media (electronic and social) preclude any confidence in the outcome of the 2014 national elections. India’s ’first-past-the-post’ system of elections and large fragmentation in all major states (3-4 meaningful political parties in key states) result in very narrow margins of victory in several cases. Thus, very small swings in vote share can alter the outcome of elections in several constituencies and of the overall elections, quite materially. Our analysis of the 2009 national elections highlights that the margin of victory was less than 6% of vote share in as many as 236 constituencies (out of 543). Appendix 1 lists the constituencies and vote shares of the major contestants. Extending this analysis to 2014 and incorporating data from state elections after the 2009 national elections (pro forma parliamentary constituency data ‘created’ from corresponding state assembly constituencies), we estimate that around 275 constituencies are very evenly poised. Also, we note that the ‘incumbent’ parties may be quite vulnerable in a few states that contributed meaningfully to the success of those parties in the last (2009) national elections. The main party in the 3-4 large states (Bharatiya Janata Party or BJP and the Indian National Congress or INC) will perhaps lose ground significantly in Andhra Pradesh (INC won 33 seats out of 42 in the 2009 national elections), Karnataka (BJP won 19 out of 28), Rajasthan (INC won 20 seats out of 25) and Tamil Nadu (DMK won 18 seats out of 39). Finally, (1) splits in political parties with the exit of dominant regional leaders, (2) break-up between erstwhile coalition partners (BJP and Janata Dal (U) in Bihar) since the last national elections and (3) a proposed bifurcation of Andhra Pradesh into two states will further complicate the political landscape. We highlight that the forthcoming state elections in four major states over November- December 2013 (see Exhibit 1) will offer some clarity on the outcome of the national elections in those states and provide some color to the outcome of the 2014 national elections. These four states account for 82 seats in the Lok Sabha (the lower house of parliament). More important, the two major national political parties in India—BJP and INC—are ‘head-on’ contenders in those four states. The INC is in power in Delhi and Rajasthan and the BJP in Chhattisgarh and Madhya Pradesh. A decisive (3-1 or 4-0) mandate in favor of any one party will be well received by the market, in our view. However, a 2-2 split will be less favorably received as it will create further confusion about the outcome of the 2014 national elections. KOTAK INSTITUTIONAL EQUITIES RESEARCH 3 India Strategy Four major states go to polls in November and December Upcoming state elections Election dates States 11-Nov and 19-Nov Chhattisgarh 25-Nov-13 Madhya Pradesh 1-Dec-13 Rajasthan 4-Dec-13 Mizoram 4-Dec-13 NCT Delhi Source: Election Commission of India, Kotak Institutional Equities The old versus the new The 2014 national elections will once again provide Indian citizens with an opportunity to debate, introspect and choose a new economic model (more aggressive capitalism and faith in markets for better allocation of resources) or to continue with the extant one (a confusing mix of capitalism and socialism). While the 2014 national elections may go the same way as previous elections with voters voting on non-economic issues and the political class promising entitlements and economic development, we make a few observations on India’s politics and its evolution over the next few years.