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Lok Sabha polls 2019: Why do elections tend to influence the stock markets?

Prior to any major election there is a lot of noise regarding the impact of the election outcome on stock markets. While it is generally perceived that elections do not matter in the long run, the truth is a bit more complicated than that. Interestingly, as the graphic below illustrates, the general elections on the last three occasions have been extremely positive for the markets.

Data Source: BSE
However, while analyzing returns post elections, one needs to keep in mind economic conditions as well as valuations. For example, in 2004, the 17% return during the quarter came despite the indices hitting the lower circuit on the results day. In 2009, markets were just coming out of the Lehman crisis and had actually bottomed out in early 2009 and therefore valuations were extremely cheap while the economy was improving. Year 2014 was slightly more complex as markets had already rallied from late 2013 on the back of the Modi wave.

In September 2013, India was on the brink of a Balance of Payments (BoP) crisis due to multiple factors like twin balance sheet issues and double digit Consumer Price Index (CPI) inflation when global markets were still dealing with the aftermath of taper tantrum. Some out of the box thinking by the Reserve Bank of India (RBI) in the form of raising money through NRE deposits saved the day. From that point, the rally continued all the way into 2015, with the markets gaining more than 70 per cent in the process. In short, the election season has been positive for the stock markets, at least in the previous three elections.

A statement of the reforms orientation

In India, reforms and politics are closely related. It has generally been seen that whenever there is a reasonably strong Government at the center reforms process have accelerated while a highly fragmented government with regional parties playing a major role have led to slowdown of the reforms process. The Narasimha Rao government with Dr. Manmohan Singh as the finance minister liberalized the Indian economy which had set up the base for strong economic growth. However, successive weak governments between 1996 to 1999 led to the derailing of the reform process which slowed down growth. Successive stable Governments between 1999 till date ensured that reform process was brought back on track which resulted in average GDP growth during the period was well above the “Hindu rate of growth” of 3.5 per cent.

 
However the period between 2009 to 2013 proved to be an exception as the reform process actually stalled despite a very strong and stable Government at the center due to emergence of one corruption scandal after another. However Union Budgets from 2014 onwards have reflected the reforms commitment of the incumbent government with efforts on long reaching reforms like the Bankruptcy Code, Goods and Services Tax (GST), simplifying Foreign Direct Investment (FDI) etc. While it is one thing to say that reforms in India are irreversible, it can be seen that strong and stable governments have been instrumental in conceiving and implementing reforms.

A vote for stability; not exactly for status quo

One of the basic principles on which stock markets are based is that a known devil is better than an unknown angel. Take the case of the United Progressive Alliance (UPA) government in 2009 and compare it with the market reaction in 2004. Back in 2004, the markets hit lower circuit when the ruling National Democratic Alliance (NDA) was voted out. However, the ability of the UPA government to push reforms by carrying the left parties along resulted in a multi-year bull rally during the UPA tenure. Therefore it was hardly surprising that the markets hit upper circuit when the UPA was voted back with a more convincing mandate in 2009. However with the reform process stalling post 2009, the 2014 general elections was a vote for change given the kind of reforms that Modi and team were promising. Despite hiccups like demonetization, the markets are overall pleased with measures like GST, RERA and the bankruptcy code which have propped up the markets. That is why the Nifty and Sensex again rallied post the Pulwama incident when the emotional tide appeared to turn in favour of the incumbent Government.

Who will bell the cat of tough reforms?

Stock markets have been about taking the risks and the tough decisions. That is when value gets created in the stock markets. Be it 1991, 1999, 2004 or 2014, it was a case of tough reforms initiated by the government that actually created wealth in the markets. The market is always looking for a courageous leader who is willing to risk short term popularity for long term economic benefits. While the merits and demerits of demonetization can be debated, it will surely go down as a bold move and the government did show the political will to stand up to its commitment. If not anything, demonetization was certainly instrumental in improving liquidity in the banking system which ensured transmission of lower rates to consumers. Similarly GST, RERA and the Bankruptcy Law also disrupted the status quo and therefore had the potential to be politically disruptive. Markets look for decisive leadership and that is where elections matters.

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Disclaimer: The above opinion is that of Jyoti Roy (Deputy Vice President - Angel Broking) & is for reference only.