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Sell the Fact on India's Charismatic New Prime Minister


The Indian stock market has surged on Narendra Modi mania, but reality is likely about to set in.

For Narendra Modi, who opened his first session of India's parliament as prime minister today, life won't get any better than this. That's likely also true of an Indian stock market that has surged on Modi mania.

Modi, a tough-talking free-market advocate who started life as a tea seller, is the first Indian leader in 25 years to win an outright majority in the Lok Sabha, the nation's usually unwieldy legislature.  That raised hopes that he can hack away at India's choking bureaucracy and reinvigorate growth from a relatively arthritic 5% annually without the need for continuous horse trading with cynical coalition partners. 

Modi stormed to victory on the promise to replicate nationally the so-called economic miracle he oversaw in Gujarat state during a decade as governor there. While Gujarat did not actually grow faster than large neighboring states in the west of the country, infrastructure improved dramatically and Modi's can-do attitude won business leaders' accolades.

Prime Minister Modi has also worked hard to sweeten his confrontational image. He cut his political teeth as a Hindu nationalist and stood by, it is said, while a pogrom killed some 1,200 Muslims in Gujarat while he was governor there. But he has been magnanimity itself on the national stage. He invited the queasy leaders of India's large Muslim neighbors, Pakistan and Bangladesh, to inaugural festivities, and reached out internally as well, declaring, "I will be prime minister of all Indians, including those who did not vote for me."  When the Lok Sabha convened under his leadership, Modi "entered amid thumping of desks," according to the Indian Express news service. Over there that is apparently a good thing.      

Investors are loving all this. The largest Indian stocks ETF on the US market, the Wisdom Tree India Earnings Fund (NYSEARCA:EPI), has risen 17% since May 1 and 34% since March 1, when the outside world began to understand that Modi was heading for triumph. That compares to an 11% gain in broader emerging markets over the same three months, as measured by the iShares MSCI Emerging Markets ETF (NYSEARCA:EEM).

Without pretending to have any specialist knowledge about India, it is a good guess that reality is about to set in.  Sometime pretty soon, Modi will stop walking on water, and markets will realize that India is India -- a country where one in four adults cannot read and gross domestic product per capita, at $4,000 per year, is less than one-half of China's and about one-third of Brazil's. The flourishing Indian diaspora we rub shoulders with in America unfortunately represents just a sliver of the home country. 

India has neither the exportable natural resources of Brazil and Russia nor, for the most part, the globally competitive export industries of China and the East Asian tigers. As a result, its current account deficit exceeded 4% of GDP last year. The outgoing government ran a budget deficit equivalent to 5.7% of GDP, driving inflation that remains stuck at 8% annually, despite interest rate hikes by India's respected central banker,  Raghuram Rajan, a former chief economist of the International Monetary Fund.  

Modi's political position is not as strong as it might seem either. His Bharatiya Janata Party won 282 out of 543 seats in the Lok Sabha, but because multiple candidates ran in most districts, that represents just 31% of the popular vote.  India's is a federalized system where much depends on regional governors, or chief ministers. Only five of 29 states are run by the BJP. The largest number are controlled by the Indian National Congress, the bitter rival that Modi's troops just trounced on the national level.

Modi may well overcome these obstacles to be the transformational leader Indians hope for. But that will take years at best. Meanwhile the market's narrative is bound to shift many times, and the macroeconomic weaknesses that earned the country a spot on Morgan Stanley's Fragile Five regain investors' attention.

Emerging markets as an asset class are likely to remain constrained until China finds its Modi. That probably won't be too soon since Xi Jinping was tapped as president a year ago for at least one five-year term. Xi's combination of impenetrable economic policy statements, heightened aggression towards his neighbors, and inaction on his country's runaway financial sector has left investors uninspired, and Chinese markets have flatlined while India surged.

Look for Brazil to get a bit of a news-flow-driven bump as the soccer World Cup this month goes better than expected and the world decides that President Dilma Rousseff isn't such a bad sort after all.  Otherwise tread carefully.
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