April 29 (Bloomberg) -- India's key stock index, the second-best performer in Asia this month, may drop 16 percent by the end of the year on concern elections will fail to bring in a government that can tackle slowing economic growth, Morgan Stanley said.
The Bombay Stock Exchange Sensitive Index may fall to 9,224 by December, down from yesterday's close of 11,001.75, analysts Ridham Desai and Sheela Rathi wrote in a report today. The forecast is 2 percent lower than an earlier target, the analysts also said, citing its "base case" analysis.
The Sensex has rallied 13 percent this month, lagging behind only Vietnam's VN Index in the region, as Indians began electing on April 16 a new government that will have to revive an economy growing at its slowest pace in six years. The index has climbed 14 percent in 2009, after tumbling a record 52 percent in the previous year.
"For India to outperform emerging markets, a relatively polarized election outcome is important," the analysts wrote. "Based on our probability-weighted scenarios, the market seems to bear downside risk from current levels in 2009."
Votes in the current elections will be counted on May 16, with opinion polls showing neither the Congress party-led United Progressive Alliance nor the main opposition, led by the Hindu- nationalist Bharatiya Janata Party, winning a clear majority.
Credit Suisse Group on April 27 advised investors to reduce their holdings of Indian stocks on concern the ongoing polls may prove a "sharp disappointment."
The Reserve Bank of India on April 21 lowered interest rates for the sixth time in as many months, saying that the economy will expand at the slowest pace since 2003. Gross domestic product may ease to 6 percent in the year that started April 1 from 7.1 percent in the previous 12 months, the central bank also said.
'Pre-election Rally'
"It is important that the new government performs a tough balancing act of stimulating the economy as well as curtailing the burgeoning fiscal deficit," the Morgan Stanley analysts wrote. "The market seems to be in its pre-election rally, which normally causes it to sell off post elections."
Earnings in India may drop 20 percent in the current year, with return on equity declining to 15 percent in the next 12 months to 18 months from its peak of 22 percent, the brokerage predicted.
"Bear markets do not end while earnings are falling," the analysts wrote. "Tactically we would sell the rallies rather than buy the dips."
To contact the reporter on this story: Chen Shiyin in Singapore at schen37@bloomberg.net .
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