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Important disclosures can be found in the Disclosures Appendix


All rights reserved. Standard Chartered Bank 2014 research.standardchartered.com
Samiran Chakraborty +91 22 6115 8820
Samiran.Chakraborty@sc.com
Regional Research
Standard Chartered Bank, India

Nagaraj Kulkarni +65 6596 6738
Nagaraj.Kulkarni@sc.com
FICC Research
Standard Chartered Bank, Singapore Branch

Bharat Shettigar +65 6596 8251
Bharat.Shettigar@sc.com
FICC Research
Standard Chartered Bank, Singapore Branch

Robert Minikin +852 3983 8567
Robert.Minikin@sc.com
FICC Research
Standard Chartered Bank (HK) Limited









































FICC Alert | 22 April 2014
India Election scenarios and market impact

We present three scenarios and likely market responses to the outcome of the ongoing general elections
Equities, FX and credit markets have partially priced in a positive election outcome; IGBs are laggards
Stay Positive on IGBs; buy 5Y IGBs (7.28% 2019), current: 8.82%, target: 8.65%, stop-loss: 9.10%
Real-money funds should remain Overweight the INR in both the short and medium term

Summary
As a sequel to our report On the Ground, 8 April 2014, India Hope builds, but
delivery will be key, we present below three possible scenarios of election outcomes
and the implications for the Indian government bond (IGB), FX and credit markets in
each scenario.

The three scenarios we envisage are as follows: (1) the Bharatiya Janata Party
(BJP)-led National Democratic Alliance (NDA) getting 240+ seats and forming a
stable government, (2) the BJP-led NDA getting between 220 and 240 seats, which
could open up several possibilities of government formation, and (3) the BJP-led
NDA getting less than 220 seats. We assign subjective probabilities of occurrence of
60% for scenario 1, 30% for scenario 2, and 10% for scenario 3.

In scenario 1, we expect unhedged total returns of c.7.3% over a three-month period
(for a foreign investor long 5Y IGBs) and credit spread compression of 15-20bps. In
the least likely scenario, we project unhedged total returns of -3.7% and a credit
spread widening of 50-60bps. We recommend that investors remain Positive on
IGBs. We stay long 5Y IGBs (7.28% 2019); entry: 8.95%, target: 8.65%, stop-loss:
9.10%, current: 8.82% on attractive valuations and favourable supply dynamics in the
<5Y segment. Real-money funds should remain short- and medium-term Overweight
the Indian rupee (INR). The risk-adjusted return for long INR versus the US dollar
(USD) is not attractive enough to recommend INR longs right now.

We think the primary impact of an election outcome on total returns will be driven by FX
rather than duration. An election outcome resembling scenario 1 could be a strong
trigger for near-term INR gains as growth expectations strengthen and inflows to
equities pick up. However, we predict a potential downward shift in the USD-INR
trading range of only 2-3% from current levels, as the Reserve Bank of India (RBI) is
likely to intervene and rebuild its FX reserves. Likewise, IGB gains could be accelerated
in this scenario as markets price in continued fiscal consolidation, better supply-side
management of inflation, and sentiment improvement in other asset markets. Such
expectations should also tighten Indian credit spreads by about 15-20bps.
Figure 1: Possible election outcome scenarios and expected market responses
Scenario
Subjective
probability
USD-INR in
3 months
(Reference
spot: 60.30)
10Y IGB yield in
3 months
(Reference yield:
8.85%)
5Y IGB yield in
3 months
(Reference
yield: 8.82%)
Unhedged 3M total
returns from long
5Y IGB
Average Z-spread
on Indian credits
1 BJP-led NDA getting 240+ seats 60% 58.0 8.65% 8.55%
7.3%
(FX: 6.2%, IGB: 1.1%)
-20bps
2
BJP-led NDA getting between
220 and 240 seats
30% 61.0 8.95% 8.85%
0.9%
(FX: 1.0%, IGB: -0.1%)
+10-15bps
3
BJP-led NDA getting less than
220 seats
10% 63.5 9.10% 9.00%
-3.7%
(FX: -3.0%, IGB: -0.7%)
+50-60bps


Source: Bloomberg, Standard Chartered Research




FICC Alert



22 April 2014 2
In scenario 2, FX and IGB gains would be limited because of the uncertainty
surrounding the composition of the new government. We may also witness moderate
outflows from equities and debt markets, leading to a rebound in USD-INR. Although
there may not be an immediate sell-off in IGBs, we do not expect substantial gains
either. In the least likely scenario 3, we expect a sell-off in both the FX and IGB
markets. The focus could shift to the risk of sustained foreign outflows from both local
equities and debt markets, which could exert pressure on the INR. We believe the
rates market will price in an increased likelihood of fiscal slippage, and sentiment in
other asset markets will worsen.

In SCout, 11 April 2014, India: Reviving growth, brick by brick, we presented our
outlook for the equities market (and foreign inflows) in three post-election scenarios
relating to GDP growth.

Elections outlook
India the worlds largest democracy, with more than 814mn voters has embarked
on a month-long national election process. Predicting the election outcome is a
hazardous task in such a large and heterogeneous democracy. The presence of
multiple political parties (370 parties contested the 2009 general elections) increases
the complexity further. We use recent opinion poll results to create a few scenarios of
election outcomes and try to assess different combinations that may push a coalition
above the majority mark of 272 seats. However, we place a caveat that opinion polls
were not accurate predictors of Indias previous two elections (see On the Ground, 8
April 2014, India Hope builds, but delivery will be key). In fact, most opinion polls
survey only an average of 60-100 persons in a constituency (the average number of
voters per constituency is close to 1.5mn).

Scenario 1: The BJP-led NDA getting 240+ seats
Most of the opinion polls are now predicting this outcome, if we include the recently
announced coalition between the BJP and the Telegu Desam Party (TDP). In such a
situation, the NDA can garner support from independents and very small parties with
less than two seats (in 2009, they got more than 25 seats) and may not require
support from any large regional party. With a stable and cohesive government, the
chances of the NDA following its growth-oriented economic programme will be
higher. Hopes of economic recovery and reduced uncertainty should encourage
investor flows to India. The asset markets should respond positively, and over-
Figure 2: The main opposition party has gained in importance
Various opinion polls over a period of time

Agency Publication date INC UPA BJP NDA Others
ABP Nielsen 7 Apr 73 92 217 236 215
CNN-IBN-Lokniti-CSDS 7 Apr 94-106 111-123 206-218 234-246 174-198
CNN-IBN-Lokniti-CSDS 7 Mar 94-110 119-139 193-213 212-232 172-212
ABP News-Nielsen 22 Feb 73 92 217 236 215
Times Now-CVoter 13 Feb 89 101 202 227 215
ABP News-Nielsen 25 Jan 81 101 210 226 216
CNN-IBN-Lokniti-CSDS 24 Jan 92-108 107-127 192-210 211-231 206-222
India Today Group-CVoter 22 Jan 91 102 188 212 229
CNN-IBN-Lokniti-CSDS 28 Oct 116-124 134-142 171-179 187-195 206-222
CNN-IBN-Lokniti-CSDS 26 Jul 131-139 149-157 156-164 172-180 206-222
Source: Media reports, Standard Chartered Research
We use recent opinion poll results
to create a few scenarios of election
outcomes
We think the probability of the BJ P-
led NDA getting 240+seats is 60%


FICC Alert



22 April 2014 3
leveraged companies should be able to reduce their leverage by raising equity or
selling non-core assets. This could be the stepping stone towards a gradual
investment recovery. If this is followed by easing supply-side bottlenecks and other
structural reforms, the growth recovery could become more robust and sustainable. A
majority in parliament will likely give the NDA the power to legislate on economic
reforms (tax, labour, foreign investment) in addition to more decisive executive
actions (on expediting project approvals and framing more business-friendly
regulation) that may not even need parliamentary approval.

Scenario 2: The BJP-led NDA getting between 220 and 240 seats
If the NDA gets seats in this range, several possibilities are likely. One, the NDA
could enter into negotiations with one or two relatively large regional parties to form a
post-poll alliance that would still be led by Narendra Modi. Two, the NDA could form
a minority government, with some of the regional parties abstaining from voting
against it. Three, the BJP may look for a different PM candidate who is more
accepting of other regional parties that are not part of the NDA coalition at present.
Until there is more clarity on which one of these possibilities will play out, the markets
are likely to remain extremely nervous. We think that a government will finally be
formed in scenario 2, but it might not have the political cohesion to push through
difficult reforms. Some regional parties might force the BJP to dilute its economic
agenda, and some others might bargain for favours. The pace of decision making
and economic reforms is likely to be slow. Sentiment in the asset markets could also
remain depressed as uncertainty prevails. If after a few months the government can
demonstrate its ability to turn around the economy through executive decisions,
sentiment could improve.

Scenario 3: The BJP-led NDA getting less than 220 seats
In this case, the NDA may not get enough new coalition partners to cross the 272-
seat mark. With no coalition securing a majority, the chances of a hung parliament
will increase. Theoretically, there is a possibility that the regional parties will come
together and form a government with support from the United Progressive Alliance
(UPA). However, we do not see this as a realistic possibility, because regional parties
are often strong competitors within particular states like the All India Anna Dravida
Munnetra Kazhagam (AIADMK) and the Dravida Munnetra Kazhagam (DMK) in
Tamil Nadu and the Samajwadi Party (SP) and the Bahujan Samaj Party (BSP) in
Uttar Pradesh. Thus, it becomes difficult for them to form an alliance at the centre. A
hung parliament will be an unexpected outcome, with sharp negative reactions in
Figure 3: INR seems to have responded positively to the
increasing popularity of the BJP
Figure 4: FII inflows to Indian equities and debt have
picked up since October 2013



Source: Media reports, Bloomberg, Standard Chartered Research Source: Media reports, Bloomberg, Standard Chartered Research
CNN-IBN-
Lokniti-
CSDS survey
Times Now-
India Today-
Cvoter
USD-INR
(RHS-inverted
scale)
59
60
61
62
63
64 100
140
180
220
260
Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14
P
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n
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B
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CNN-IBN-
Lokniti-
CSDS survey
Total FII
inflows to
Indian equities
and debt in
the month
(USD bn,
RHS)
0
1
2
3
4
5
6
150
160
170
180
190
200
210
220
230
Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14
P
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We think the probability of the BJ P-
led NDA getting less than 220 seats
is 10%
The probability of the BJ P-led NDA
getting between 220 and 240 seats
is 30%, in our view


FICC Alert



22 April 2014 4
financial markets. Even if the NDA is somehow able to form a minority government
with less than 220 seats, markets are likely to question its stability and its ability to
make decisions.

Based on opinion poll results and factoring in the possibility of errors in the surveys,
we assign subjective probabilities of 60% for scenario 1, followed by 30% for
scenario 2 and 10% for scenario 3. It will not be possible for us to update these
subjective probabilities, because no more opinion/exit polls will be allowed until the
election process is over on 12 May. While at present, markets are focused on 16 May
when the election results will be announced, the political process after the elections
is likely to have a more prolonged impact on the markets. They will likely keenly
watch for the composition of the ruling coalition (i.e., which regional parties decide to
join it and under what conditions); the choice of ministers for critical ministries;
decisions of the new government in the first few days of coming to power, particularly
budget proposals; and the speed at which the economy responds to those decisions.

Market outlook
Rates market
The impact of an election outcome on the IGB market has been limited in the past.
The medium-term trend in IGB yields after the elections depends more on the
macroeconomic backdrop at the time of elections. Interestingly, the last two elections
(2004 and 2009) were held at the trough of the policy rate cycle (May 2004) and the
inflation cycle (May 2009). In 2004, IGB yields increased by 150bps within three
months after the elections in anticipation of policy-rate hikes that started in October.
In 2009, WPI inflation spiked to 7.15% in December from 1.45% in May, leading to
yields increasing by c.70bps in the three months after the election results were
announced.

We think the current macroeconomic backdrop is different from that in 2004 and
2009. In March 2014, CPI inflation was at 8.3% y/y very close to the RBIs end-
December 2014 target. We expect only a moderate uptick in CPI inflation in Q2-2014
on the back of adverse base effects and weather-related disturbances. However,
inflation will likely trend downwards in H2-2014 as the base effect turns favourable. In
our view, the RBI is likely to ignore these transitory factors and keep policy rates
steady for some time. Thus, unlike during the previous elections, we may already be
close to the peak of the policy rate cycle this time. With the benchmark 10Y IGB yield
Figure 5: Credit markets have also rallied, partly due to
the government meeting its FY14 headline fiscal target
Figure 6: IGBs have remained range-bound and not
responded to the improvement in election sentiment



Source: Media reports, Bloomberg, Standard Chartered Research Source: Media reports, Bloomberg, Standard Chartered Research
CNN-IBN-
Lokniti-
CSDS survey
SBI 5Y CDS
spread (bps,
RHS-inverted
scale)
200
250
300
350 100
140
180
220
260
Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14
P
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Times Now-India Today-Cvoter
CNN-IBN-
Lokniti-
CSDS survey
10Y IGB yield
(%, RHS-
inverted scale)
8.25
8.50
8.75
9.00
9.25 100
140
180
220
260
Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14
P
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Times Now-India Today-Cvoter
The 2004 elections were held at the
trough of the policy rate cycle, and
the 2009 elections at the trough of
the inflation cycle
Markets will watch for the
composition of the ruling coalition,
the choice of individuals for critical
ministries, and budget proposals
after the elections are over
We think the current
macroeconomic backdrop is
different from that in 2004 and 2009


FICC Alert



22 April 2014 5
c.100bps higher than the policy rate, we think the IGB markets are adequately pricing
in the likelihood that the central banks tight monetary policy stance will continue. The
daily average of this spread when the repo rate was operative has only been about
35bps from January 2005 to date. In a more recent period from January 2011 to
December 2013 it averaged about 55bps. Thus, our base-case view is for 10Y IGB
yields to decline amid a stable policy rate environment with improving external-sector
dynamics.

If the outcome of the elections resembles scenario 1, IGB gains may accelerate. The
markets would likely price in continued fiscal consolidation and better supply-side
management of inflation, with sentiment improvement in other asset markets also
potentially benefiting the IGB market. Overall macro stability could bring in foreign
demand, partly reversing the fall in demand from the RBI. The bond market will
keenly watch the first budget of the newly elected government to assess its fiscal
stance. If the budget does not announce any additional borrowing, the bond market
will likely be relieved. The BJPs manifesto for the 2014 election emphasises fiscal
discipline; indeed, during 1999-2004 (when the BJP-led NDA was in power), it
managed the fiscal deficit well.

The disinvestment process started during the NDA regime, and it may become an
essential component of bridging the revenue expenditure gap if the BJP-led NDA is
elected. However, the urge to fulfil election promises could increase expenditure in
the new governments first year. The manifesto also lists several specific measures
to address supply-side issues plaguing inflation. The RBI would be more comfortable
about relaxing its tight monetary policy stance if these supply-side measures are
successful. Finally, we expect sentiment in other asset markets, particularly FX, to
improve substantially, which will have a spillover impact on IGBs.

Scenario 2 could make the bond markets nervous until there is more clarity on the
formation of the new government. Although there may not be an immediate sell-off;
we do not expect substantial gains either.

In a less likely scenario 3 (a high chance of a hung parliament), IGBs may sell off.
The rates market would price in an increased likelihood of fiscal slippage and
worsening sentiment in other asset markets. The focus could shift to possible foreign
outflows from both local equities and debt markets, which could exert pressure on the
INR.
Figure 7: Monetary policy backdrop for 2014 elections is
different from that in the past two elections
Figure 8: FII inflows to equities stronger than to debt
Cumulative flows since 1 February 2014, USD bn



Source: Bloomberg, Standard Chartered Research Source: Bloomberg, Standard Chartered Research
2004 Elections 2009 Elections
10Y IGB yield
Repo rate
Reverse repo
rate
3
4
5
6
7
8
9
10
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Equities
LCY debt
(IGBs + T-bills
+ Corporate
debt)
-1
0
1
2
3
4
5
6
2-Feb-14 17-Feb-14 4-Mar-14 19-Mar-14 3-Apr-14
If the outcome of the elections
resembles scenario 1, IGB gains
may accelerate
Scenario 2 could make the bond
markets nervous until there is more
clarity on the formation of the new
government


FICC Alert



22 April 2014 6
FX market
Since September 2013, the INR has benefited from policy response to last years
currency depreciation, and improving macros have reinforced the stabilisation
process. However, India will need to return to a high growth path and see more
sustainable improvements to its current account deficit for the INR rebound to be
extended. We believe that amid such a backdrop, FX markets will keenly watch the
election outcome to assess any change in policy framework adopted by the new
government. However, until the election results are clear, USD-INR is likely to trade
between 59.50 and 61.50. This is very close to the level that RBI Governor Rajan
characterised as fair value for the INR, and it seems likely the RBI will be
successful in fostering INR stability around this level in the very near term. The
governor recently opined that USD-INR of 55.0 would leave the INR at too strong a
level (although this conclusion is very dependent on the measure of Indian inflation
used in assessing INR valuations).

An election outcome resembling scenario 1 could trigger near-term INR gains, as
markets may not have completely priced in such an outcome. This could potentially
shift the USD-INR trading range lower by 2-3% from current levels. A cohesive and
decisive BJP-led coalition government will lead to expectations of a growth recovery
by focusing on infrastructure and manufacturing. In our view, the key propositions of
the BJPs manifesto that have a high probability of implementation are accelerated
and time-bound (including environmental) clearances in the manufacturing sector, its
strong emphasis on infrastructure development, and its proposal to rationalise the tax
regime (see On the Ground, 8 April 2014, India Hope builds, but delivery will be
key). As highlighted in SCout, 11 April 2014, India: Reviving growth, brick by brick,
in a scenario where the likelihood of growth bouncing back to 7.0-7.5% increases
(possibly in conjunction with a strong and stable government in FY15, year starting 1
April 2014), FII inflows could be USD 10-15bn per annum.

We think the FX markets have only partially priced in the likelihood of scenario 1, as
uncertainty about the accuracy of opinion polls persist. If the election results indicate
a stable government, the INR may gain further from increased capital inflows. YTD,
the INR has gained only 2.5% against the USD, while comparable emerging-market
(EM) currencies like the Indonesian rupiah (IDR) and the Brazilian real (BRL) have
gained c.5-7%. The INR therefore has scope to appreciate on a favourable election
outcome. Moreover, domestic exporters have hedge ratios of c.30-35%, which are
Figure 9: Growth recovery is key for INR appreciation

Figure 10: INR has underperformed its peers
YTD spot returns versus the USD, %



Source: Bloomberg, Standard Chartered Research Source: Bloomberg, Standard Chartered Research
39
44
49
54
59
64 4
5
6
7
8
9
10
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
USD-INR (RHS,
inverted)
Consensus GDP
forecast (% y/y)
-2 0 2 4 6 8
IDR
BRL
INR
THB
MYR
PHP
ZAR
FX markets will likely keenly watch
the election outcome to assess the
change in policy framework
adopted by the new government
In scenario 1, the INR trading range
could shift to 58-60
The INR has gained only 2.5%
against the USD YTD, while
comparable EM currencies like the
IDR and the BRL have gained c.5-
7%


FICC Alert



22 April 2014 7
likely to increase as the INR gains momentum. This should also propel the INRs
advance. However, the RBI is likely to moderate such appreciation pressures to
rebuild its FX reserve cover.

In the scenario of a BJP-led coalition government getting between 220 to 240 seats,
we expect a knee-jerk mild sell-off in the INR as markets brace for an uncertain
period of political negotiations to form a government.

As a result, we may also witness moderate outflows from both the equity and debt
markets. Foreign investors were overweight Indian equities in the MSCI as of end-
December 2013; we think this may reduce if scenario 2 materialises (see SCout, 11
April 2014, India: Reviving growth, brick by brick). Investor confidence is unlikely to
return to FX markets till the new governments policy framework becomes clear.

In a less likely scenario 3 outcome (a high chance of a hung parliament), investors
would be disappointed, and we expect the INR to retrace its gains since its low of
63.11 in January 2014. The RBIs support may be required to stabilise the INR, as
USD-INR could trade beyond the RBIs comfort level.

Credit markets
To assess the impact of the election results on Indian credit spreads, we need to
analyse two factors Indias credit rating trajectory and where Indian credit spreads
are in the context of broader Asian and EM markets.

Indias ratings came under pressure in mid-2013 due to a low growth rate, currency
depreciation and capital flight. However, since then, the authorities have used a
variety of policy tools to narrow the current account deficit, while monetary policy has
been more assertive in addressing inflation concerns. Importantly, the government
managed to contain the FY14 fiscal deficit at 4.6% of GDP, versus initial estimates of
4.8%. While the quality of fiscal consolidation is somewhat questionable (due to
significant cuts in planned expenditure, a rollover of subsidy payments, one-off
revenue from telecom spectrum auctions and dividend payments from state-owned
companies), ratings pressure has clearly abated. The budget to be announced by the
new government will determine the FY15 fiscal outcome and longer-term trends that
could affect the sovereign credit profile.

Figure 11: Average Indian credit spreads against peers
Z-spread, bps
Figure 12: Benchmark Indian bonds against peers
Duration, Z-spread, bps



Source: Standard Chartered Research

Source: Standard Chartered Research
China
Thailand
India
Indonesia
150
200
250
300
350
400
450
Jul-13 Oct-13 Jan-14 Apr-14
ONGCIN 18
RILIN 20
BHARTI 23
NTPCIN 22
PTTEPT 18
TOPTB 23
PCCW 23
NANFUN 22
CHCONS 18
CHINAM 22
BRTFOD 18
SBIIN 18
EXIMBK 23
ICICI 20
IDBI 19
BBLTB 18
BBLTB 23
AGSBB 23
BCHINA 23
BBRIIJ 18
BBNIIJ 17
130
175
220
265
310
2.6 3.1 3.6 4.1 4.6 5.1 5.6 6.1 6.6 7.1 7.6
Increased chances of a hung
parliament would disappoint equity
investors; the INR may sell off, too
Indian credit spreads have
tightened recently on a gradual
improvement in macro
fundamentals


FICC Alert



22 April 2014 8
Indian credit spreads have tightened sharply in the past six months due to the
gradual improvement in the macro picture. Since September 2013, Indian credit
spreads have come in by about 140bps (Figure 1) and are currently trading broadly
in line with the low-BBB credit space in Asia. We believe markets are currently
pricing in a negligible possibility of a rating downgrade, which we believe is fair.
Hence, we have an overall Neutral recommendation on Indian credits, with a
preference for corporates over bank senior paper.

The possibility of a sovereign downgrade is the biggest concern for credit investors.
They will likely be looking at election results to get further clarity on this. As
highlighted in the previous paragraph, the pressure of a rating downgrade has
reduced significantly given the improvement in the fiscal and current account
positions. Thus, if the election outcome resembles scenario 1, Indian credit spreads
could tighten further by about 20bps in three months. While a strong showing by the
BJP-led NDA would not, by itself, translate into an immediate improvement in
economic growth and fiscal consolidation, the markets would likely price in the
potential for longer-term structural improvements, which has been a big concern for
the rating agencies. Also, if the new government sticks close to the 4.1% fiscal deficit
target announced for FY15 by the current government and takes some initial steps
towards this, S&P will likely revert Indias sovereign rating outlook back to stable in
H2-2014. Such a scenario would be more beneficial for the bonds issued by quasi-
sovereign corporates and senior financials in particular, as the rating of these entities
is directly linked to sovereign ratings. Bonds issued by private corporates like
Reliance Industries Ltd., Bharti Ltd. and Vedanta Resources are unlikely to benefit
directly, but they will likely benefit indirectly from improved sentiment.

If the election outcome resembles scenario 2, Indian spreads could see a mild sell-off
(of about 10-15bps), as investors would prefer to take profits and wait for more clarity
on the new governments composition and policy stance. In this scenario, private
corporates could outperform marginally given the lack of direct linkage to sovereign
ratings.

However, if scenario 3 plays out, Indian credit spreads will likely see a much sharper
sell-off (of at least 50-60bps). Investors will likely believe that the lack of a common
economic agenda would make it difficult for the new government to implement
contentious reforms or undertake meaningful fiscal correction. This in turn could lead
to capital flight, currency pressure and a negative feedback loop for credit markets. In
case of scenario 3, we also see an increased probability of S&P downgrading the
ratings and/or Moodys changing the outlook to negative over a 6- to 12-month
period. In such a scenario, we would expect spread widening across all sectors.
However, downstream oil and gas names like Indian Oil and Bharat Petroleum that
bear the brunt of the oil-subsidy burden could be exposed more. Fragmented polity
under scenario 3 and the related economic uncertainty would impact the banking
sector as well in terms of slower credit growth and further asset-quality pressure.
This could lead the banking-sector credits to underperform. The smaller state-owned
banks with weaker credit fundamentals would be affected more from a fundamental
perspective. That said, the sell-off in bonds could in fact be led by the larger and
relatively strong banks as they are much more widely held by international
investors and thus would attract larger selling pressure. In such a scenario,
privately owned corporates, especially names with large international/export
operations (such as Reliance, Bharti and Vedanta) would be less affected
fundamentally and are likely to outperform substantially.
A positive election outcome could
tighten Indian credit spreads by
about 15-20bps
In scenario 3, the credit spread will
likely see a sharper sell-off of c.50-
60bps

In scenario 1, credit spreads could
tighten further by 20bps


FICC Alert



22 April 2014 9
Local markets strategy
We recommend that investors remain Positive on both the INR and IGBs.
Specifically, we recommend buying 5Y IGBs (7.28% 2019) at the current yield of
8.82% (entry: 8.95%, target: 8.65%, and stop-loss: 9.10%). In the most likely
scenario (1), where the BJP-led NDA gets 240+ seats, we expect unhedged total
returns of c.7.3% for a foreign investor long 5Y IGBs (c.6.2% from FX and c.1.1%
from IGBs).

An election outcome resembling scenario 1 could be a strong trigger for near-term
INR gains and could potentially shift the USD-INR trading band lower by 2-3% from
current levels. A cohesive and decisive BJP-led coalition government will lead to
expectations of a growth recovery by focusing on infrastructure and manufacturing.
We think scenario 1 is only partially priced in by the FX markets, as uncertainty about
the accuracy of opinion polls persist. Moreover, we think domestic exporters have
hedge ratios of c.30-35%, which are likely to increase as the INR gains momentum.
This should also help INR gains. Likewise, IGB gains could accelerate in this
scenario as markets price in continued fiscal consolidation, better supply-side
management of inflation, and sentiment improvement in other asset markets.

In scenario 2, FX gains would be limited by the uncertainty surrounding the
composition of the new government. We may also witness moderate outflows from
the equity and debt markets, leading to a rebound in USD-INR. But adjusted for
carry, FX returns would still be positive. The IGB market could be nervous, too.
Although there may not be an immediate sell-off, we do not expect substantial gains
either.

In the least likely scenario 3, we expect a sell-off in both the FX and the IGB markets,
resulting in unhedged total returns of -3.7% (-3.0% from FX and -0.7% from IGBs) in
a long 5Y IGB position. The focus could shift to possible foreign outflows from both
the local equity and debt markets, which could exert pressure on the INR. The rates
market will likely price in an increased likelihood of fiscal slippage and worsening
sentiment in other asset markets.

Based on the analysis of a marginal impact of the elections on the local markets, our
recommendation of long 5Y IGBs is based on the most likely outcome of the
elections (scenario 1). However, there are several other supporting factors that make
the pay-off from this trade asymmetric. As highlighted in Rates Alert, 16 April 2014,
IGB valuations are attractive; buy 5Y IGBs, we think the 5Y IGB valuations are
attractive in a stable policy-rate environment. Despite a moderate uptick in near-term
CPI inflation prints, a strong base effect has the potential to reduce CPI inflation to
the 6.5-7.0% range in H2-2014. Supply dynamics (in the <5Y segment) and local
market positioning are also favourable. With the rationalisation of the IGB quota for
FIIs (i.e., no incremental investment allowed in T-bills), future FII inflows will likely be
to 1Y-5Y IGBs. We think a positive election outcome could accelerate inflows to this
segment. However, the risk-adjusted return for the long INR versus USD position is
not attractive enough to recommend a long INR trade right now. Our estimates of
Sharpe ratios for such a trade are in the range of 0.6 to 1.0.



We recommend that investors
remain Positive on both the INR and
IGBs
Unhedged total returns for foreign
investors long 5Y IGBs are as
follows:
scenario 1: +7.3%,
scenario 2: +0.9%,
scenario 3: -3.7%
We recommend buying 5Y IGBs
(7.28% 2019) at the current yield of
8.82% (entry: 8.95%, target: 8.65%,
and stop-loss: 9.10%)


FICC Alert



22 April 2014 10
Figure 13: Estimates of total returns in the three scenarios of election
outcomes

Scenario
(A)
Probability of
occurrence of
scenario
(B)
3M returns on
long 5Y IGB
position
(C)
3M returns on
long INR vs.
USD position
(D)
3M total returns
from unhedged
long 5Y IGB
position
(E=C+D)
1 60% 1.10% 6.20% 7.30%
2 30% -0.10% 1.00% 0.90%
3 10% -0.70% -3.00% -3.70%
Expected returns 0.61% 3.70% 4.31%

Note: INR returns are based on onshore forwards; Source: Standard Chartered Research


Figure 14: Key dates and events that may affect the markets

Date Event
12-May-14 Announcement of various exit-poll results
16-May-14 Announcement of election results
30-May-14 Formation of the new government
Mid/End June 2014 Announcement of FY15 union budget

Source: Standard Chartered Research





FICC Alert



22 April 2014 11
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Document approved by
Will Oswald
Global Head of FICC Research
Document is released at
01:01 GMT 22 April 2014

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