Options traders are paying the most in almost two years to protect against swings in Indian stocks as concern grows that a government will emerge from national elections without a parliamentary majority.
The spread between the CNX Nifty Index’s three-month implied volatility and the gauge’s actual price swings was 6.8 at the end of last week, data compiled by Bloomberg show. That’s near the highest level since March 2012, reached Jan. 29. The gap, a measure of how much investors are paying to hedge, has widened from minus 6.2 in October, while the Nifty fell 5 percent from its all-time high on Dec. 9.
Indian shares have slid amid concern that the opposition Bharatiya Janata Party’s victories at state polls in December won’t give it enough momentum to win a parliamentary majority in the world’s largest democracy. A weak government will face a tougher time approving policy changes needed to revive growth from a decade low and avoid a credit-rating downgrade to junk.
“The view that a BJP-led government will come to power will be seriously challenged in the days to come and that will pressure stocks,” Dipen Sheth, the head of institutional research at HDFC Securities Ltd. in Mumbai, said in a Feb. 13 interview. “Investors will shuffle uncomfortably on the edge of their seats as there’s a lot of scope to inflict damage in India before polls. All bets are now on the elections.”
The BJP-led coalition may secure 227 seats, while Prime Minister Manmohan Singh’s Congress-led coalition will win 101 seats, with neither getting a majority, a Times Now-CVoter survey predicted Feb. 13. The survey forecast 215 seats for the regional parties in the 545-member parliament. Eleven regional parties said this month they are in talks to forge a competing alliance to oppose groupings led by Congress and the BJP.
The emergence of a fragmented coalition may weaken the rupee and heighten risks to India’s credit ratings, Moody’s Investors Service said Feb. 11. Standard & Poor’s warned in November that India’s rating may be cut to junk unless the polls lead to a government capable of reviving economic expansion.
“Investors are concerned that a government formed by regional parties may be unstable and investor-unfriendly,” Modan Saha, chief executive officer at Axis Securities Ltd., said in a Feb. 11 interview in Mumbai.
While Congress has been hurt by slow growth and high consumer prices, investors are speculating that Narendra Modi, the BJP’s prime ministerial candidate, will be able to fast-track projects in a nation ranked bottom among the four largest emerging markets in the World Bank’s 2013 Ease of Doing Business Index.
Modi’s home state of Gujarat has recorded annual growth of 10 percent, lured investments by companies from Ford Motor Co. to the Tata Group and raised power-generation capacity by more than fivefold since he became chief minister in 2001.
The Nifty gauge, which includes Infosys Ltd. and HDFC Bank Ltd., climbed to a record on Dec. 9 after global investors bought $20 billion of shares in 2013, the most in Asia after Japan, data compiled by Bloomberg show. The index has slid 4.1 percent this year. The most-owned contract on the gauge is a February 6,000 put, which has an exercise level 0.8 percent below the last close, the data show.
India forecast its economy will expand 4.9 percent in the 12 months through March 31, faster than the decade-low growth of 4.5 percent last year, the statistics ministry said Feb. 7. Interest-rate increases aimed at cooling inflation and less government spending could reduce growth.
India last month joined nations from Brazil to Turkey in raising interest rates to curb consumer prices and shield the rupee after a reduction in U.S. monetary stimulus hurt emerging-market assets. While a report on Feb. 14 showed the wholesale-price index in January fell to a eight-month low, a gauge of core inflation held at 8 percent, signaling limited scope for the Reserve Bank of India to cut borrowing costs.
RBI Governor Raghuram Rajan last month said curbing price pressures is crucial to support growth. If inflation slows, the economy can grow between 5 percent and 6 percent in the fiscal year ending March 2015, according to the central bank.
Equity valuations lower than their historical averages may support the market, said Vaibhav Sanghavi, a director at Ambit Investment Advisors Pvt. in Mumbai. The Nifty is valued at 13 times projected 12-month earnings, compared with the average multiple of 14.3 over the past five years.
“We don’t anticipate a big selloff,” Sanghavi said by phone on Feb 14. “Elections are still some time away.”
Still, the possibility of an unstable coalition will boost volatility, according to Taher Badshah, co-head of equities at Mumbai-based Motilal Oswal Asset Management Co.
The India VIX, which measures the cost of Nifty options, may rise to 24 in a month, according to Ravi Sharma, a derivatives analyst at Prabhudas Lilladher Pvt. in Mumbai. The gauge jumped 10 percent last week and reached a two-month high of 19.05 on Feb. 10. The measure lost 5 percent to 15.83 today.
“The market view is blurry as the political mandate is not at all clear,” Motilal’s Badshah said.