Factbox-What investors expect from India's election outcome

By Ankur Banerjee, Jayshree P Upadhyay and Bharath Rajeswaran

SINGAPORE/MUMBAI/BENGALURU (Reuters) - India's six-week long national election, the world's largest, has entered its final stage with votes scheduled to be counted on June 4, and investors are gearing up for Prime Minister Narendra Modi's widely expected third term in office.

However, the margin of victory may be smaller than earlier expected, analysts and informal betting markets are speculating.

Here are the main themes and comments from over 10 fund managers Reuters spoke to on their expectations based on different scenarios.

HOW WILL MARKETS REACT?

Indian equities outperformed most major markets in 2023 and are trading at expensive valuations. Yet, they could see a short term boost if the Modi administration comes back to power in a rare third consecutive term for any Indian government, fund managers said, as it would suggest policy continuity and political stability.

The benchmark BSE Sensex Index is up 4% so far this year, with a Reuters poll of equity analysts indicating the index could double the gains by the end of the year.

Foreign investors poured in a net $20.74 billion into Indian equities last year, the most in emerging markets in Asia, but have pulled back this year ahead of the election.

A lower margin of victory for Modi could lead to short-term volatility, fund managers said, while a win for the opposition could lead to a sharper correction due to policy uncertainty.

"The market is looking at continuity, so a coalition government or another party winning is not the expectation," said Mittul Kalawadia, senior equity fund manager at Mumbai-based ICICI Prudential Mutual Fund.

"There can be a knee-jerk reaction if the last scenario builds up," Kalawadia said.

POLICY CONTINUITY

A third term for a Modi-led government will allow for continuity of policies, including improved fiscal management and keeping the currency stable.

"In the last couple of years, India had a good amount of stability in terms of the current account gap and fiscal discipline, and inflation has been in check," said Ashish Gupta, chief investment officer at Mumbai-based Axis Mutual Fund, who expects the focus on macroeconomic stability to continue.

"This has led to, both on debt as well as equity side, India’s risk premium coming down," Gupta said.

Investors also expect the Modi government to continue focusing on turning the country into a manufacturing hub.

Modi's government has courted foreign companies, including Apple and Tesla, to set up in India as they diversify their supply chains beyond China.

A clear electoral mandate and a government perceived as pro-business and investor-friendly will likely attract foreign investment inflows, said Vivek Bhutoria, co-portfolio manager at Federated Hermes' global emerging markets equity fund, based in London.

TAX STABILITY

The election campaign has seen India's largest opposition party, the Congress, hint at policies aimed at addressing income inequalities in India but investors remain wary of such moves.

"We would like the BJP to stay away (from) over-reliance on welfare schemes," said Gary Tan, portfolio manager at Allspring Global investments in Singapore.

Overdependence on such schemes can stress public finances and disrupt India's macro stability narrative, Tan said.

Local media reports have also suggested the government may consider changes in capital gains tax, which the current administration has denied.

Nilesh Shah, chief executive officer of Kotak Mahindra Asset Management, does not expect the government to go down that route and instead introduce policies to deepen capital markets.

SECTORS IN FOCUS

With the current government focused on spending on infrastructure and pushing manufacturing, fund managers are leaning towards sectors that benefit from these policies.

Power, autos and infrastructure are some of the sectors that investors are positive on.

"We are constructive on beneficiaries from India's focus on manufacturing such as capital goods firms, automotives and metals," said Sanjay Bembalkar, co-head of equities at Mumbai- based Union Asset Management Company.

(Reporting by Ankur Banerjee in Singapore; Jayshree P. Upadhyay in Mumbai and Bharath Rajeswaran in Bangalore; Writing by Ira Dugal; Editing by Muralikumar Anantharaman)