How will the Election Impact Markets

The 2014 Indian election is officially underway. In just over a month from now, we will know our next Prime Minister, and the composition of the Lok Sabha. An important question for investors is how the results of the election will impact the markets. The election matters both for short and long term market movements. 

During the last general election in 2009, Congress won a greater than expected number of seats, and the Indian stock markets rose 17% over the two days following the election result. In the previous general election in 2004, when the BJP unexpectedly lost, the markets fell 17% over the two days after the election results. This information tells us that whatever the result of Indian election, we can expect stock markets to be extremely volatile in the days immediately after the result. 

If the BJP win the election comfortably, meaning that they gain enough seats to build a stable coalition expected to push through significant economic reforms, then markets will rally. Markets have been rising in recent weeks in anticipation of this, and a resounding victory for the BJP will confirm these movements. 

On the other hand, if other small parties do better than expected, this would hinder the likelihood of economic reforms getting put in place, and will impact the markets negatively as a result. For example, if the Aam Aadmi Party performs well, this would weaken the power of the ruling party. If the BJP does worse than expected, or the Congress does better than expected, markets will likely take a large hit following the elections. 

While most analysts do expect the BJP to win comfortably, past history tells us that Indian elections are far from predictable. This is due to the large and diverse electorate that make up the Indian voters. In both the 2009 and 2004 elections, the results ended up surprising everyone, and this caused significant market movements following those results. 

In the upcoming election, the greater risk for markets is to the downside. Markets have rallied anticipating that the BJP will win comfortably, and so this event is largely priced into the markets already. However, markets could fall significantly if there was another unexpected result.