Governments that do not respect central bank independence will sooner or later incur the wrath of financial markets, ignite economic fire, and come to rue the day they undermined an important regulatory institution," Viral Acharya, deputy governor of the Reserve Bank of India (RBI), said less than two months ago. Since then, there has been a furious debate about the independence of the central bank. News reports had suggested that RBI governor Urjit Patel will resign in protest against attempts to influence the central bank’s policies.

That day has come. While Patel has officially said he is quitting because of personal reasons, the acrimony between RBI and the government on policy matters has left little to the imagination.

For investors, especially those from foreign shores, interfering with central bank independence is a touchy subject. It’s little wonder the rupee fell by 1.6% in non-deliverable forward (NDF) markets overseas. The three-month NDF rate now predicts the rupee to weaken to as much as 73.20 to a dollar from 71 last week. American Depository Receipts (ADRs) of HDFC Bank Ltd and ICICI Bank Ltd fell 6%, signalling a sharp correction when India’s equity markets resume trading on Tuesday.

“RBI is a sensitive institution and markets accord a great deal of significance to its autonomy and credibility," said Arvind Chari, head (fixed income) at Quantum Advisory Pvt. Ltd.

Still, the news of Patel’s resignation, in itself, is unlikely to result in a massive sell-off. Much depends on what the government’s next moves are. “The focus would now be on the process of appointing the new RBI governor that the government follows. It is of critical significance to choose a successor whom the market sees as independent and trustworthy," says Chari.

According to the head of research at a multinational brokerage firm, “While there will be a knee-jerk reaction because foreign investors dislike government interference with the central bank’s independence, things may settle down once there is clarity on matters such as interest rate policy and regulation of public sector banks." The markets may very well welcome a shift in stance and a more accommodative policy on interest rates and weak public sector banks, he said.

However, as far as today’s trading session goes, investors will be keenly watching the assembly election results. Investors already got the jitters when exit poll results suggested a close fight between the Bharatiya Janata Party (BJP) and the Congress in three large states, which is a big negative as far as investor sentiment goes. An anti-incumbency wave was expected in Rajasthan, but the BJP was expected to win in Madhya Pradesh and Chattisgarh by a fair margin.

“A 0-3 (BJP losing all the three states) or 1-2 score (BJP losing Madhya Pradesh and Rajasthan) may result in a sharp market correction as the market will likely take a dim view of the BJP’s prospects in the next national elections given the large contribution of these three states to its 2014 win," analysts at Kotak Institutional Equities said in a note to clients.

On the other hand, a 2-1 score in favour of the BJP will bring relief to investors, as it will be taken as a sign that the political party has a better chance in next year’s general election. Based on the markets’ reaction on Monday, the equity market could now be factoring-in a low margin win for the BJP in the 2019 election, cautioned analysts. As such, the outcome of the state elections will have a huge bearing on where markets end up on Tuesday.

Monday’s reaction to the exit poll results shows clearly that markets are on the edge. Despite a correction this year, valuations of Indian stocks are still high relative to emerging market peers.

“High valuations amidst high earnings downgrade risks keep us cautious on the market," Standard Chartered Securities (India) Ltd said in report on 30 November.

Global equity markets have also been rough. Asian markets fell on Monday as concerns about the US-China trade tensions came to the fore again. Worries of an economic slowdown and Brexit took its toll on European stocks as well.

Of course, the saving grace is that oil prices have corrected sharply since October and has, in turn, helped the local currency appreciate. Things would have been far worse if news of the governor’s exit had hit when the rupee was already at the 75 level.