Does politics affect financial markets? On Thursday evening, May 9th, 2024, my friend texted me that the market is bleeding. I wasn’t surprised. This has been happening for the past five trading sessions. On that day, the Sensex lost 1,000 points, or 1.45%. Investors lost Rs 11 lakh crores in three days. The Economic Times reported one reason being low voter turnout in the first three phases of the ongoing Lok Sabha elections.
Additionally, there has been selling pressure on the Nifty Bank index for the past seven sessions, resulting in a 1,900-point loss. While these political factors play a role, other reasons include heavy sell-offs by Foreign Institutional Investors (FIIs), disappointing Quarter 4-2024 results, and the US Federal Reserve’s policies. However, today’s discussion primarily revolves around the question: Does politics affect financial markets?
Key Elections in 2024- Does Politics Affect Financial Markets?
In 2024, numerous countries around the world will hold significant elections. Some of the important ones include the United States, European Union, Pakistan, India, Ukraine, and Taiwan. These elections can have substantial implications for both domestic and international political landscapes, which in turn affects the financial markets.
Pakistan held its election on February 8, 2024. It was both marred by issues and hopeful, as per a post published by Madiha Afzal in Brookings. India’s 18th Lok Sabha elections are being held from April 19 to June 1, 2024, in seven phases. Reports indicate an unprecedented turnout, making this election the longest in history at 44 days, second only to the Indian general election of 1951-1952. This significant political activity has contributed to the turbulence in the Indian stock market. Here’s a closer look.
Given the limited space, I can only provide data for specific dates. For a broader analysis, please visit Investing.com and examine the overall trend. To take our discussion further, we need to look at the historical context of how politics has affected financial markets in the past. But before that, we will take a brief look at the Political Business Cycle Theory by Michal Kalecki.
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Michal Kalecki Political Business Cycle Model
As an Economics and Finance alumni, I often reflect on various economic theories that help explain real-world phenomena. One such theory is Michal Kalecki’s Political Business Cycle Model.
Michal Kalecki, a prominent economist, proposed the Political Business Cycle Theory to explain how political motives can influence economic policies and consequently, economic cycles. According to Kalecki, elected officials often manipulate economic policies to influence election outcomes and voter behaviour. Before elections, governments may implement expansionary measures like tax cuts and increased expenditure to boost the economy. However, post-election, these are often followed by contractionary measures to control inflation and budget deficits, leading to economic slowdowns.
The result of these politically motivated policies is a cyclical pattern where the economy experiences artificial booms before elections and slowdowns after elections.
Application to the Indian Context
Understanding Kalecki’s theory helps analyse the current scenario in India:
Pre-Election Stimulus: Before elections, the government may adopt populist measures to win voter support, such as subsidies, increased public sector hiring, and infrastructure projects. While these measures can boost the stock market in the short term, they may lead to fiscal deficits and inflationary pressures post-election.
Post-Election Austerity: After the elections, necessary but unpopular measures, like cutting subsidies and increasing taxes, might be implemented to stabilize the economy. These measures can negatively impact market sentiment and lead to market corrections.
By examining past instances, we can see a pattern of market reactions to political events, providing valuable insights for investors.
Past Example: The 2004 Indian General Elections and the Stock Market
Context: The elections were held from April 20 to May 10, 2004.
The incumbent government, led by the National Democratic Alliance (NDA) and Prime Minister Atal Bihari Vajpayee, was widely expected to win due to its economic reforms and perceived strong performance.
Market Sentiment and Reaction:
-The stock market was generally bullish leading up to the elections, buoyed by optimism about continued economic growth and stability under the NDA.
-The unexpected victory of the United Progressive Alliance (UPA), led by the Indian National Congress, resulted in a sharp market decline.
Immediate Impact: On May 17, 2004, the Sensex plummeted by 842 points, or nearly 17%, triggering trading halts twice in a single day. This dramatic drop is often referred to as “Black Monday” in the Indian stock market. For more details, refer the sources: Who pulled the trigger on Black Monday? or India’s stock market suffers biggest fall in its 129-year history
The unexpected political outcome in the 2004 Indian general elections caused significant market volatility, illustrating the impact of politics on financial markets.
Historical Context- Does politics affect financial markets?
Moving on to our discussion, let’s examine various historical instances where political policies and initiatives have caused turbulence in the Indian stock market. This analysis will help us determine whether politics affect financial markets.
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1. Economic Liberalization (1991) and its affect on the Indian Stock Market
Economic liberalisation in India, initiated in 1991 under Prime Minister P.V. Narasimha Rao and Finance Minister Dr Manmohan Singh, marked a significant transition from a closed, centrally planned economy to a market-oriented one. Key reforms included deregulation, privatisation, trade liberalisation, and financial sector modernisation.
Context: 1991 Balance of Payments Crisis: The liberalisation was a response to a severe economic crisis, demonstrating political will to implement necessary reforms.
Economic Turbulence: The crisis led to economic liberalisation reforms, including devaluation of the rupee, reduction in tariffs, and inviting foreign investments.
Key Impacts:
–Increased Foreign Investment: Attracted significant foreign direct investment (FDI) and foreign institutional investment (FII), boosting market liquidity and confidence.
–Market Growth: The Bombay Stock Exchange (BSE) Sensex rose from around 1,000 points in 1990 to approximately 4,500 points by 2000, reflecting increased investor confidence.
–New Financial Instruments: Introduction of derivatives and other instruments enhanced risk management and market depth.
–Improved Market Efficiency: Empowered regulatory bodies like SEBI to ensure market transparency and protect investor interests.
With highs and lows along the road, the BSE Sensex, the oldest stock index including 30 businesses, has come a long way. From an average of 1,440 points in July 1991 to an all-time high of 75124.28 on April 9, 2024.
2. The 2008 Economic Recession and its Impact on the Indian Stock Market
The 2008 global financial crisis, triggered by the collapse of Lehman Brothers and a meltdown in the US housing market, had significant repercussions for the Indian stock market. The Sensex plummeted from a high of 21,000 points in January 2008 to around 8,000 points by October 2008. Thus marking a drastic decline.
Available: https://www.adb.org/sites/default/files/publication/156019/adbi-wp164.pdf
Political Involvement:
Government Response: The Indian government and the Reserve Bank of India (RBI) implemented several measures to stabilize the economy. This included liquidity infusion, interest rate cuts, and fiscal stimulus packages.
Regulatory Measures: SEBI relaxed norms to boost investor confidence and ensured market stability.
Recovery Path:
Stimulus Packages: The government announced stimulus packages totaling around $80 billion to boost demand and support various sectors.
Monetary Easing: The RBI cut interest rates from 9% to 4.75% between October 2008 and April 2009, making borrowing cheaper and encouraging investment.
Economic Reforms: Continued focus on economic reforms and infrastructure development helped the economy regain momentum.
Path Ahead:
Growth Resumption: By mid-2009, the Indian stock market began to recover, with the Sensex reaching pre-crisis levels by late 2010.
Sustained Reforms: Long-term growth was supported by ongoing economic reforms, robust domestic demand, and a resilient banking sector.
3. Demonetization (2016) and its Impact on the Indian Stock Market
On November 8, 2016, Prime Minister Narendra Modi announced the demonetisation of Rs 500 and Rs 1,000 currency notes. The aim was to combat black money, counterfeit currency, and corruption. This action affected the Indian economy and stock market both short- and long-term, and overnight it invalidated 86% of the money in circulation.
Economic Impact:
Market Reaction: The Sensex initially fell by over 1,689 points or 6.4% in just four trading days following the announcement, reflecting investor uncertainty and a liquidity crunch.
Sectoral Impact: Sectors heavily reliant on cash transactions, such as real estate, consumer goods, and small businesses, faced immediate downturns. The BSE Realty index, for instance, fell by around 12% in the immediate aftermath.
Short-term Disruption: A significant cash crunch disrupted daily economic activities and reduced consumer spending. The GDP growth rate slowed down to 6.1% in Q4 2016-17 from 7.5% in Q2 2016-17.
Political Involvement:
Government Justification: The government defended demonetization as a necessary step to eradicate black money and promote digital transactions.
Economic Measures: The Reserve Bank of India (RBI) and the government took steps to mitigate the impact, including easing cash withdrawal limits and promoting digital payment methods.
Recovery Path:
Economic Adjustment: The economy gradually adjusted as the remonetisation process proceeded, and digital transactions increased.
Market Stabilization: By early 2017, the Sensex began to recover, reaching new highs by mid-2017 as investor confidence returned.
Long-Term Reforms: Demonetization accelerated the formalization of the economy and boosted digital payments infrastructure, aligning with the government’s vision of a less-cash economy.
Read more here –Demonetisation Effect on Share Market
4. The COVID-19 Pandemic and its Impact on the Indian Stock Market
The COVID-19 pandemic, which began in late 2019 and rapidly spread across the globe in early 2020, had an unprecedented impact on economies and stock markets worldwide. India was no exception, with the Indian stock market experiencing significant volatility and downturns as the pandemic unfolded.
Immediate Impact:
–Market Reaction: In March 2020, the BSE Sensex plunged from around 42,000 points to approximately 26,000 points, a drop of nearly 38%. Thus reflecting panic selling and uncertainty about the economic impact of the pandemic. The Sensex saw its biggest one-day decline ever on March 23, 2020, falling 3,934.72 points (13.15%) to end at 25,981.24.
–Sectoral Impact: Sectors such as travel, hospitality, and retail were hit hardest due to lockdowns and restrictions, while healthcare and technology sectors saw increased investor interest. The BSE Healthcare index rose by 50% over the year as demand for medical supplies surged.
Political Involvement:
Government Measures: The Indian government implemented several measures to mitigate the economic fallout. This included a 6 billion economic stimulus package aimed at supporting small businesses, providing direct cash transfers, and boosting healthcare infrastructure.
RBI Actions: The Reserve Bank of India (RBI) reduced the repo rate by 115 basis points to 4%. Further, it announced various liquidity measures to ensure sufficient credit flow to businesses.
Recovery Path:
Economic Adjustment: As lockdowns were gradually lifted and vaccination drives began, economic activity started to recover. The government’s focus on infrastructure and manufacturing, particularly through initiatives like “Atmanirbhar Bharat” (Self-Reliant India), helped boost investor confidence.
Market Stabilization: By the end of 2020, the Sensex had rebounded to pre-pandemic levels, closing at around 47,000 points. This was driven by robust corporate earnings and positive economic indicators. By early 2021, the Sensex had recovered significantly, crossing the 50,000 mark in January 2021.
Read more here- Indian Stock Market During COVID-19 Pandemic: Vulnerable or Resilient? – Sector Analysis
Does Politics Affect Financial Markets?
All these historic events show the interrelation between politics and the stock market. By looking at these instances, we can clearly address the question: Does politics affect financial markets? Indeed, political decisions and events have a profound impact on market dynamics, causing fluctuations and influencing investor sentiment.
Currently, one of the biggest events in India is ongoing—the General Elections or the Lok Sabha elections of 2024. The 18th Lok Sabha elections, scheduled to choose the 15th Prime Minister of the country on June 4, 2024, are crucial. The ruling party is confident about returning to power, claiming they will win 400+ seats out of 543. However, low voter turnout is causing fluctuations in the stock market, adding to the existing volatility.
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Current Scenario in India:
Market Reaction: The Indian stock market has been experiencing significant turbulence due to the elections. Low voter turnout in the initial phases has heightened uncertainty, leading to market declines. There are indications of recovery and development potential even in the face of a slump in certain sectors, such as banking, energy, and telecommunications.
Investor Sentiment: Investors are closely monitoring the election results, as the political stability of the ruling party significantly affects market confidence and future economic policies.
Economic Indicators: Other factors, such as the performance of Q4 2024 corporate earnings, foreign institutional investor (FII) activity, and global economic conditions, also contribute to market volatility.
Sectoral Impact: Certain industries, like IT and pharmaceuticals, have proven resilient, while others, like banking and real estate, have been more unstable because of political and economic unpredictability.
Strategies for Investors
–Diversification: Spread investments across various sectors and asset classes to mitigate risk.
–Focus on Fundamentals: Invest in companies with strong fundamentals and robust business models that can withstand economic fluctuations.
–Stay Informed: Keep abreast of domestic and global economic developments, policy changes, and corporate earnings reports.
–Long-Term Perspective: Maintain a long-term investment horizon to ride out short-term volatility and benefit from market recoveries.
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Conclusion
And so we have reached to our final discussion of our today’s topic- Does politics affect financial markets? It surely does. Historical events and the current market scenario attests to this interconnection. The Indian stock market’s current turbulence is driven by a complex interplay of global economic uncertainties, domestic economic challenges, and political factors. By understanding these influences and adopting prudent investment strategies, investors can navigate this volatility and position themselves for potential market rebounds.
This analysis synthesizes recent trends and historical contexts, providing a comprehensive view of the factors affecting the Indian stock market.
That’s all for today’s post. Hope you get some valuable insights from here.
Happy reading!
Disclaimer
The blog is meant for informational purposes and serves the general analysis of the stocks. The contents provided here are based on careful research and analysis utilizing the fundamental and technical indicators over a while. The post does not have any direct recommendations about investing or trading in the securities market. Thorough research and careful consideration are necessary for individuals to fulfill their responsibility in making financial decisions. Seeking professional advice before making any financial decisions is always advisable.
