Are markets ignoring political risk?

Are markets ignoring political risk?
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First Published: Thu, May 14 2009. 11 51 PM IST

Updated: Thu, May 14 2009. 11 51 PM IST
If the exit polls are correct, forming a government is going to be a tortuous process and the next ruling coalition will be a fragile affair. Yet the benchmark Sensex index on the Bombay Stock Exchange did better than most of the Asian indices on Thursday, staving off the worst of the expected double whammy from the prospect of prolonged political uncertainty and faltering global markets.
Are investors being foolhardy in not taking some money off the table before the election results are announced? Are they ignoring political risk? Perhaps not, if history is any guide.
Anubhuti Sahay, economist with Standard Chartered Bank says in a recent research note: “Though a knee jerk reaction cannot be ruled out, historical clues indicate that markets are driven more by economic fundamentals rather than political events over the medium term.”
Also See No trends at all (Graphic)
Let’s take what the market assumes to be the worst case, a non-Congress, non-Bharatiya Janata Party government. At the beginning of May 1996, the Sensex was at 3,827 points and it was at 3,816 on 16 May, when BJP’s Atal Bihari Vajpayee was sworn in. He wasn’t able to get the required support and H.D. Deve Gowda became prime minister on 1 June.
The Sensex fluctuated between 3,500 and 3,800 points over the period, opening at 3,731 on 3 June. The index reached a high of 4,131 on 17 June, but did precious little after that, ending the year at 3,085 points. During Deve Gowda and successor I.K. Gujral’s government, the Sensex reached a high of 4,605 in August 1997 and a low of 3,388 in November. When Vajpayee returned to power in March 1998, the Sensex moved up a bit, reaching a high of 3,999 points on 24 March but, essentially, the market remained completely range-bound all through those years.
What about the track record of the more stable governments? The market did rally briefly after the installation of Vajpayee as prime minister in 1999, but that was more because of the dotcom frenzy than anything else, just as the markets during the United Front days suffered because of the Asian crisis. Despite the market-friendly and reform-friendly nature of the Vajpayee government, the markets remained mired in gloom during 2001-03, because of the dot-com bust.
On the contrary, despite a Left-supported government in 2004 and no reforms to speak of, after the initial sell-off, the markets rallied handsomely because global markets took off on a spectacular bull run. A Goldman Sachs note by Tushar Poddar and Pranjul Bhandari on the impact of the elections says: “Directionally, global markets have had a greater impact on the stock market than elections in that year” and elections do not significantly interfere with the business cycle.
That ties in with research that has studied the correlation of political risk with equity market returns in the Asia-Pacific region. A study in the Australian Journal of Management by Richard Heaney and Vince Hooper titled World, Regional and Political Risk Influences upon Asia Pacific Equity Market returns says: “Country-specific political risk indices provide very little time-series explanatory power over equity market returns.”
Graphics by Ahmed Raza Khan / Mint
Write to us at marktomarket@livemint.com
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First Published: Thu, May 14 2009. 11 51 PM IST