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Published on 23/01/2019 5:10:59 PM | Source: HT Media

Opinion | A possible patchwork Parliament is freaking out Indian investors

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Election results have meant many things to many people. But Election 2019 is throwing up a new constituency of worries about election results. Equity investors are increasingly asking the question: who knows what elections will throw up this time, should I get out of equity? The frequency of this question being asked is increasing as the elections get closer. The possibility of a patchwork Parliament is freaking out most first-time (and some older) equity investors. The fear is of an unstable government that overturns the growth and reform path that India has followed since 1991. Equity investors have understood that markets do well when governments push the pedal on economic reform.

The fears of a patchwork Parliament are real, but I would not pull out of the equity market for four reasons. One, assuming that the patchwork does indeed come to power, the growth path that India set out on in 1991 has now gained momentum. To hard press brakes on a $2.6 trillion economy will not be that easy. Reforms, when they become law, such as the bankruptcy law or the goods and services tax (GST), are not that easy to turn around. A fragile patchwork government may not have the heft to get these U-turns through Parliament and do major damage. The fear of policy uncertainly and paralysis is there, but not of a U-turn.

Two, this patchwork Parliament will either work or not. If it manages to contain the internal contradictions and provides stability, it is good news. There could be slippages on the fiscal front, but not that much on the growth momentum. If it is not able to work through the contradictions, it falls, and either the BJP or the Congress comes to power. Barring the shorter-term cost of policy uncertainty and maybe another election, the long-term growth path of the economy looks good.

Three, stock markets in the past have not shown any correlation with elections. An analysis from the HDFC Mutual Fund Yearbook 2019 shows data from March 1979 till March 2018, and gives one-year absolute returns for 39 years. There have been 10 elections over these years and none of these elections caused any drop in the market in the year of the election (see graph). In fact, the worst that happened was a 0% return in 1997. The report says: “As can be noticed there is no pattern in S&P BSE Sensex returns during the year in which elections were held or in years before or after the elections." So, the data shows that elections don’t impact markets in India.

Four, if the BJP does come back, the markets will make a one-time V shaped post-election recovery. The market likes the structural reform this government has attempted and remains bullish on taking these reforms further. Those who step out of the market now run the risk of losing that bump of market rise.

You need to think the line of argument that compels you to exit equity due to the possibility of a patchwork Parliament. If you are really afraid of this election outcome for your stocks, you should worry about your bonds as well. In fact, the bond market will react far more sharply than the equity market, causing your bond portfolio to lose as well. The path to safety then is only in gold and not even fixed deposits. Remember, a fiscally imprudent government will cause another bumper round of inflation, causing all your “safe" money in fixed deposits to lose value as a cynical government inflates away its debt. To ride out Election 2019, you have to do nothing different than what you would have done in Election 2014. You have to put the money you do not need for at least seven years in the stock market. Anything you need before that you should remove. This is a good time to look at your asset allocation and keep the faith. We survived 1991 and 2008. We’ll get through Election 2019 as well.

End note

There are four pipelines that bring trillions of rupees of household money into the stock market—the Employees’ Provident Fund Organisation (EPFO), National Pension System (NPS), Ulips and mutual funds. The wrinkle about what a patchwork government will do to their money is now spread across lakhs of investors. It is possibly a good sign that, as more people begin to invest in market-linked products—both bonds and stocks—they become more responsive to the kinds of voting choices they make. Growth or protection? Fiscal prudence or freebies? Black money or white? The Indian politician is a very adaptive creature. And once he figures out that a certain number of votes go for market reform and growth, that’s what we will get.

Monika Halan is consulting editor at Mint and writes on household finance, policy and regulation