There’s only one thing on everybody’s mind now and that’s the general election. We’re concerned about which combination of parties will come to power and what impact it will have on the quality of governance, on the economy and on the markets. It’s not only political reporters and psephologists who are having a field day—even the brokerages have jumped into the fray. Every broking house worth its salt has published its analysis of the election results and why it is so important for the markets.
Here’s a fairly typical sample, from Motilal Oswal: “In 1QFY10, the most important event for the markets would be the General Elections scheduled for April-May 2009. Market reaction was very adverse to the unexpected outcome of the elections in May 2004. The recent history of state election results in Rajasthan, Madhya Pradesh, Chhattisgarh, Delhi, Jammu and Kashmir, etc., and the stance of various regional parties do not provide any pointers to the likely winner. While the government will be formed through a coalition of multiple political parties (no single party is likely to win a majority on its own), the dominant party, its allies and their willingness to introduce economic reforms would be a significant catalyst for Indian equities. This becomes even more important in the current environment of economic slowdown.”
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The analysis is simple—if we have a reform-friendly government, that will improve the economy and, therefore, the markets. But the connection between domestic economic growth and the stock market has been rather tenuous. For instance, in the mid-90s, the economy grew at 6.4% in 1994-95, 7.3% in 1995-96 and 8% in 1996-97, rates of growth that were well above the average for the 1990s. And this is what happened to the benchmark Sensex index on the Bombay Stock Exchange over the period: It went down from 3,926 points at the end of 1994 to 3,658 by the end of calendar 1997. To be sure, there were rallies and there were troughs during the period, but the net effect was that the market was lower at the end of 1997 than it was at the end of 1994. And if you object that by the end of 1997 we were already in the credit crunch, well, the Sensex was even lower, at 3,085, at the end of calendar 1996.
What about the connection between economic reform and the markets? Everybody, without exception, has excoriated the United Progressive Alliance (UPA) government for doing nothing on economic reform in the last five years. Even if it did have some reformist instincts, those were kept well in check by the Left. The result: the most spectacular bull run in the markets during this no-reform period. It’s true, though, that the bull run coincided with a superb period for the economy, with three years of above 9% growth. But the simple truth is that this huge jump in economic growth was the result of extraordinary growth for the global economy as a whole.
Economic growth in India, as well as in the rest of the world, was very high simply because it was fuelled by excessively high liquidity—the result of very low interest rates, very high leverage and the unchecked growth of derivatives. Ditto for the markets—the huge inflows of foreign money pumped up the value of stocks. And this is true not just during the boom years of 2003-07 but also earlier during the dotcom boom and even earlier during the early 90s.
The point is that India is not decoupled and what happens to the global economy inevitably has its impact on India. So it didn’t really matter that economic reform was put on the back burner during the UPA’s tenure. Rather what mattered was the liquidity. Similarly, if liquidity is absent, even disinvestment may not be sufficient to attract money to the markets, as was seen during the preceding National Democratic Alliance rule in the early 2000s. Even the argument that a stable government is needed to administer the next dose of fiscal stimulus needs to be taken with a pinch of salt. There really isn’t much room for another fiscal push. Even if it is needed, it’s difficult to see which party could possibly object to it. Even the Left, which has been arguing all along for a higher fiscal deficit, is unlikely to object. No party is also likely to object to measures that would increase spending on infrastructure or raising loans from the World Bank. And as for monetary policy, the Reserve Bank of India is perfectly capable of doing whatever is needed. No other group except the Left is likely to be bothered much about disinvestment.
To be sure, governance does matter. During 1999-2000 to 2005-06, Gujarat’s state domestic product (SDP) at current prices grew by 101.7%. Over the same period, Haryana’s SDP at current prices went up by 101.1%. In contrast, Bihar’s growth over the period was 54.6%. But notice that Punjab’s SDP at current prices too was up only 51.1%. So maybe governance and being investor-friendly is not enough. True, a hung Parliament that cannot cobble a government together would spook the markets. And of course, money would certainly flow in if foreign direct investment norms are relaxed and disinvestment is restarted. But the impact of those measures will be minuscule compared with the huge changes that are likely to take place in the global economy as a result of the current crisis.
Investors would do well to focus on those momentous changes, which will have far greater impact on both the economy and the markets, than the election results.
Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at firstname.lastname@example.org