Will the Lok Sabha election impact market?

We analysed Sensex movement, macro data and fund flows since 1980 to find out how these elections impact stocks

The polling for electing members of the 17th Lok Sabha is about to begin in a few months and psephologists and political analysts are already working over-time, trying to understand and interpret voter behaviour.

The outcome of the State Assembly elections of Rajasthan, Telangana, Madhya Pradesh, Mizoram and Chattisgarh, will also be closely scrutinised to provide clues about voters’ inclinations.

Should investors in Indian stocks and mutual funds be worried about the coming general elections? A section of analysts is of the opinion that general elections do not impact the market much, besides causing short-term volatility. Some others think that such insouciant attitude is unwarranted as the fate of the economy and Indian corporates hinges on this election.

We decided to check which of these camps is right by looking at some key data points around the Lok Sabha elections held since 1980. We analysed stock market behaviour, macro data and foreign fund flows around these elections; the period prior to 1980 could not be considered due to non-availability of stock market data.

It is true that the economy and the market are influenced by external drivers too, such as crude oil, currency markets, global growth, liquidity in financial markets etc. But the extent of stability in the Centre seems to play an important part in determining stock price movement.

Stock market moves

We studied the movement of the Sensex, three months before and three months after the election results month to see the short-term reaction of the market to the polls. For any sustained reaction, we also studied the change in Sensex, one year after the elections.

If we consider the returns made by the Sensex in the quarter preceding the elections, the market seems to be mostly in a nervy state. In the 10 elections we considered, the Sensex gave single-digit returns in five instances and negative returns in three. The maximum pre-election gain was made before the May 2009 election, but that was largely due to the bounce-back from the 2008 crisis-lows. The next highest pre-election return was in 2014, when the Modi-wave made stocks spiral higher before the polls.

In the quarter following the polls, the election outcome plays a big part in Sensex movement. The polls in which government was formed by parties with thumping majority, akin to the one in May 2014 or December 1984— when Rajiv Gandhi rode on a sympathy wave following Indira Gandhi’s assassination, to get 404 seats — the Sensex delivered double-digit returns in the quarter following the elections.

The 1980 election — Indira Gandhi’s last term as Prime Minister — was an exception, when the Sensex was almost flat, despite the Congress winning 353 seats. This could be due to the geopolitical tensions and threat of recession, depressing stock prices.

On the other hand, the market has turned nervous when the government at the Centre has been unsteady. In 1996, the poll outcome was a hung Parliament and a government was cobbled together by non-Congress and non-BJP parties, with HD Deve Gowda as the Prime Minister, following BJP’s 13-day government under Atal Bihari Vajpayee.

The Sensex declined 5 per cent in the quarter following the elections; clearly, investors were not amused by the shenanigans of their elected leaders.

A similar thumbs-down was given to the government formed under VP Singh’s leadership in 1989 with BJP supporting from outside. The Sensex was flat in the quarter following the LS formation.

That said, the market has been ready to accept coalition governments, provided the leadership was perceived as capable. The NDA government under AB Vajpayee in 1999 and the Congress government with allies under PV Narasimha Rao in 1991 were welcomed by the market; the Sensex was up 17.12 per cent and 30.16 per cent in the quarters following the polls in the two instances.

One-year after the LS polls, the macro economic influences — both domestic and global — seem to play a larger role in influencing market sentiment. But in the three polls where the largest party had a clear majority — 1980, 1984 and 2014 — the Sensex delivered double-digit returns, a year later. Stability does seem to go down well with market-men.

Takeaway: Sensex returns in the three months prior to the polls are either in single-digits or negative. Returns in the quarter after the polls depend on the perceived stability of the government. One year later, governments with a clear majority give better market returns.

Elections and growth

There are many who feel that the Indian economic growth is agnostic to the government at the Centre. This view is belied by the growth numbers in the two most volatile periods in the history of Lok Sabha since 1980s — that between December 1989 and June 1991 and between May 1996 and May 1998.

In the December 1989 elections, VP Singh formed the government, despite the Congress possessing 197 seats in the House. Internal bickering among the regional parties in the coalition; Advani’s Rath Yatra to the Babri Masjid site in 1990; unseating of VP Singh and Chandra Shekhar coming to power — may have thwarted any cohesive thinking on policies for economic growth in this period. GDP growth, according to World Bank data, was 5.5 per cent in 1990, but plummeted to 1.05 per cent in 1991.

This unstable period may have contributed to the economic crisis that took India to the brink of debt default in 1991 when the PV Narasimha Rao and Manmohan Singh duo had to pledge Indian gold to the IMF and World Bank to salvage the situation.






Interestingly, economic growth faltered between May 1996 and 1998 too, when the country was led by three Prime Ministers — AB Vajpayee (13 days), Deve Gowda (324 days) and I K Gujral (332 days). In this period, BJP, despite having the maximum number of seats was unable to form the government. India’s GDP growth was 7.5 per cent in 1996, but dipped to 4.04 per cent in 1997 before recovering to 6.18 per cent in 1998. The growth following the economic reforms unleashed in 1992, seems to have faltered under this makeshift government.

On the other hand, coalitions led by the largest party in terms of number of seats, have seen the GDP trot along at a steady pace.

Takeaway: Economic growth is at risk if a coalition government is formed by excluding the party with maximum seats.


Sectoral trends

We attempted to understand the sectors that could be impacted by the Lok Sabha election by studying the growth in key aggregates of national income and gross value added (GVA) by economic activity, based on the back-series numbers released by MOSPI recently. A few trends from this data could be of interest to investors in stocks.

Gross fixed capital formation (GFCF) that represents capital spending on building assets, invariably takes a hit prior to Lok Sabha polls. This could be due to the ruling party reducing allocation to infrastructure and other capital spends to find the money for populist measures. Slowing approvals for private construction projects and private sector going slow with capex could be other reasons. Growth in GFCF over the previous year, was 16.3 per cent in 2007-08. But it declined to 3.2 per cent in 2008-09, only to pick up to 7.7 per cent in 2009-10. Similarly, GFCF growth plunged to 1.6 per cent in 2013-14, from 4.9 per cent the previous year, just ahead of the 2014 poll.

The GFCF includes public, private and household spends on dwellings, other buildings and structures and on machinery and equipment. It, therefore appears that new project launches in roads, real estate, bridges, and so on, might not be launched in the months preceding the polls. Similarly purchase of machinery for brownfield or greenfield expansion of plants might also take a back-seat prior to the polls. This can impact the order flow of construction as well as capital goods players.

A closer look at the GVA by economic activity shows that a few segments show some unusual activity around Lok Sabha polls. For instance, GVA of electricity, gas, water supply and other utility services increases just before these polls. The GVA growth in this segment was 3.4 per cent in the December 2013 quarter and 5.4 per cent in the March 2014 quarter. But the growth bumped up to 9 per cent in the June 2014 quarter. The party in power probably tries not to irk the voters by ensuring that the utilities function smoothly when voting is in progress. This short-term increase in output is, however, not likely to help listed utility players much, given their other problems such as non-availability of fuel, low demand reducing plant utilisation and large debt piles of power generators.

Similarly, GVA of services related to communication and broadcasting seems to benefit from the polls. GVA growth in this segment was 16 per cent in 2013-14, up from 6.8 per cent the previous year. This one is, however, a no-brainer as it’s an open secret that companies in the print media space, especially vernacular dailies, gain higher advertising revenue around the polls. But listed companies in print media are not banking too much on this revenue, going by their earnings calls.

Takeaway: The growth in order books of infrastructure companies taper in the quarters before the polls. The revenue of utility companies and print media companies increases in the quarter preceding the polls, but that will not materially impact their earnings.

Election and fund flows

We analysed the foreign portfolio investors’ and mutual funds’ net purchases into the equity market around the last three LS elections – 2014, 2009 and 2004 – to see if general elections have impacted institutional flows.

Mutual fund flows were more sensitive to elections and domestic funds seemed to be taking more tactical decisions when compared with foreign investors. For instance, FPIs brought in copious amounts in the three months before all three elections. Mutual funds were however net sellers before 2014 polls, probably booking profits due to the sharp stock price rally in the preceding year. Before 2004 polls too, MFs made negligible purchases.

FPIs have continued to net-purchase stocks after the polls as well. But we should not read too much into the FPI numbers in the 2009-2015 period as the inflows were largely due to monetary easing by global central banks. With Fed and other banks now on the monetary tightening path, FPIs are not likely to emulate this trend in the 2019 election.

MFs turned gung-ho after the 2014 result, ploughing-in over ₹15,000 crore in the months following the result. However, after the May 2004 polls, they pulled out money.

Takeaway: Mutual funds could taper their purchases in the quarter preceding the polls, if there is a large degree of uncertainty. Their action after the polls will depend on the outcome. FPIs are unlikely to lend support in 2019 due to tightening liquidity conditions in global financial markets.

Investor dos and don’ts

It is not easy to read the tea leaves to forecast what the outcome of the next LS polls is going to be. There are three scenarios that can emerge after the polls. One, the ruling NDA, may return to power. But anti-incumbency, ill-will garnered through demonetisation, farmer protests, and so on, could reduce the number of seats it gets. If the NDA does not get majority, but manages to form the government with the support of whimsical allies, the market will not be happy, but it will not be disruptive either. Two, if NDA’s seat share whittles down considerably and a shaky non-BJP coalition forms the government, that would be the worst-case scenario for stocks. Three, Modi returning to power for a second term with clear majority, while unlikely, could be the best scenario for stocks.

Besides election, there are a host of other negatives for the market at this point. While stocks have corrected, valuation is not yet cheap. Uncertainty over crude prices, trade war, global growth and increasing interest rates will cast a shadow on global equities over the coming quarters. Government’s capital spends are also likely to slow ahead of elections. The positive for the market at this point is the mutual fund SIP inflows that provides a cushion in protracted declines.

Given these issues, investors need to be circumspect about equities over the next six months. Staggered buying through mutual fund SIP route appears the safest. Lump-sum buying can be done once there is clarity on the election outcome.

If you are a direct investor, you can adopt a bottom-up approach to picking large-caps that have declined in recent times. It’s best to steer clear of mid- and small-cap stocks as they will be further pummelled if there is a sell-off, post-elections.

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