>India Strategy (MERRILL LYNCH)

India elections: Musical chairs post elections

· Hung parliament likely…
Over next 6-8 weeks, we think concerns of a hung Parliament post-election will likely worry the market and, coupled with expected slowing earnings, we believe could lead to a 15% correction in the markets. On the elections, we believe
(a) there will likely be a hung Parliament i.e. none of the three combinations – Congress-led UPA, BJP-led NDA and the Third Front – will be able to come to power (b) post-election results new alliances are likely –regional parties like BSP and AIADMK will be important (c) the probability of a Third Front Government coming to power is still low but increasing in our view. Our best case scenario would be a Congress Government but with the Left being a key ally in it.

· …leading to new alliances in effort to form the Government
We think most of the present alliances are fluid and many parties would be willing to reconsider their alliances post-elections. We think 2 regional parties – Mayawati’s BSP and Jayalalita’s AIADMK would play a crucial role in deciding the Government. The role of the Left parties, though weakened, should also be important.

· Congress-led UPA Government still has a slight edge
Despite the break-down of seat sharing with Mulayam Singh’s SP in U.P and Laloo Yadav’s RJD in Bihar, we think both will continue to be part of the Congress-led UPA. We think the UPA still has a slight edge since they can get
Left support again. The BJP-led NDA on the other hand, we believe, could need the support of BSP, Jayalalita’s AIADMK, Naidu’s TDP as well as its old ally BJD.

· Third Front Government: Negative scenario for the market
We think it would be highly unlikely that a Third Front Government is formed without the support of Congress or BJP, because Congress plus BJP should gain nearly 50% of the total seats. However, if the Congress/BJP can’t form a stable Government, they may support a Third Front Government. While we think this is a lower probability event, the possibility has been increasing past few weeks.

· Markets edgy till Government formed
We think a positive scenario for the market is a BJP or Congress led Government without the Left parties but has a low probability event in our view. Historically, markets have been edgy ahead of elections. We think concerns of a hung Parliament could lead to a 15% correction in markets this time. We would be defensive (Buy Hero Honda, Bharti) in the run-up to elections. We think infrastructure would be a priority for all Governments – Jaiprakash could be a gainer in the post-election scenario. We believe a Congress or BJP government without the Left could lead to reforms in (a) privatization and oil reforms (gainers: HPCL/BPCL) (b) banking reforms (gainers: Government banks) (c) FDI in retail, aviation, insurance etc (gainers: Pantaloon).

To see full report: INDIA STRATEGY