Impact of Political Ambiguity on Indian Stock Market

Indian Stock Market has come off sharply in last couple of month owing to poor economic data, political uncertainty and global financial instability. While GDP for Q3 FY2013 came in at its decade low of 4.5%, at the same time, a higher inflation has tied RBI hands to ease monetary policy. As a result, price of rupee is going down against dollar which is putting further pressure on our twin deficits.

While on one hand Government has shown some resolve to tackle the bulging subsidy burden by partial decontrol of diesel, on the other hand, in a populist measure, it has cleared an ambitious food-security bill that would allow 67% of the population access to cheap food gains.

Now with the withdrawal of DMK from UPA 2, chances are that we may still get an election in late 2013 which mean that Government has all of 6-9 months to get its house in order. Expectedly, the news sent shockwaves in the markets which fell off sharply despite a rate cut by RBI on the same day. While chances of an immediate election seems remote considering that most of the parties are unprepared, one still cannot rule out the possibility especially since the Government stability now depends upon ever fluctuating SP and BSP.

However, what’s more worrying for the market is the fact that if ruling party i.e. Congress now decides to go into election mode, there may be a slew of populist measures which may put the economic prudence in jeopardy. Also, no party appears to emerge stronger in the recent years and chances are that we may get a fractured mandate in next Lok Sabha election as well which may lead to some volatility in stock markets.

The effect of political risk is also on Capital Flows. So far India has received decent capital flows despite the cracks in the current account deficit, which is expected to top 6% of GDP for the third quarter of this fiscal year. The government has made many reform promises and targeted an ambitious 4.8% of gross domestic product (GDP) fiscal deficit for the next fiscal year. Any increase in uncertainty will cause the capital flows to run off the country. In the worst case scenario of early elections, there could even be some outflows in the near term. That, in turn, will have a unbearable effect on the rupee, setting off a vicious cycle of an increasing current account deficit and depreciating currency.

Conclusion

While withdrawal of support by DMK has definitely raised doubts about the fate of the government's economic reforms agenda, the statement by Finance Minister implies that Government may still continue with its drive as that is that only way they can prevent a rating downgrade and salvage some of the lost ground of preceding 3 years. Also, stock markets will be keenly watching the action on the sidelines for any signs of stability or shakiness which will determine future direction for markets.

By Ruchita Gajjar– Research Associate – Concept Securities Private Limited