How election years affect the stock market

March 10, 2014

(Any opinions expressed here are those of the author and not of Thomson Reuters)

The ongoing stock market rally has been primarily supported by foreign investors. The rupee also rose to a near three-month high against the dollar on Friday.

It is rather unusual for the Indian market to jump in pre-election months, particularly after 1996 when coalitions became the new political strategy to make up for shortfalls in parliamentary majority. In most election years, the market had actually fallen just before the elections – in 2004, by more than 10 percent.

There are reasons why the Sensex is behaving differently now.

The market has its own fears and hopes. First, the market detests uncertainty, which is at its peak in coalition times with regional parties vying for power.

Second, the market would like the communist parties to be drowned in political backwaters. Though a few regional parties want to assert their right to influence the government at the centre, the Bharatiya Janata Party (BJP) can still command a good number of seats from the states that it already rules as well as others. This has generated some confidence in investors who are looking to make some quick gains.

That confidence may have come partly from opinion surveys announced recently. Most of them forecast that the BJP may capture more seats than the Congress did in 2009 and be in a good position to form the government with support from old and new friends. If that happens, how will the market respond to the political change?

Well, the BJP-led National Democratic Alliance had come to power in 1999. At the time, the market responded well in the three months before the elections (the Sensex jumped nearly 17 percent) as also in the three months following the elections (the Sensex jumped another 6.4 percent). But the euphoria did not last long. In the one year after the elections, the Sensex dropped 13 percent.

The market trend was different in 2004 when a Congress-led coalition formed the government. That is because it had to rely on the communist parties to remain in power. In the first three months, the Sensex was down 6 percent, though over the year it was up 16 percent.

This year, investors seem excited with expectations that the BJP will form the next government with Narendra Modi as the prime minister. They hope he will give priority to development by reforming policies and governance.

The present rally may not continue for long and the market is more likely to move sideways. Political uncertainty is high. But if the BJP comes to power, the Sensex is bound to jump with enough support coming from foreign institutional investors. That will also harden the rupee further. However, over a longer period, it is possible that the Sensex can slide, depending on how much a new government remains true to its word.

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