But the possibility, even if an outside one, that the AAP can spread to a few more cities could make the market mood turn cautious. Indeed, while the markets rallied smartly intra-day on Thursday after Wednesday evenings exit polls signalled the BJP might make a clean sweep in four states, by the close of the session both benchmark indices had pared their gains.
The Street has been betting big on Narendra Modi, chief minister of Gujarat and the prime ministerial candidate for the BJP. Indeed, much of the markets resilience over the past few months has been attributed to expectations that the BJP, led by Modi, would form a strong stable government at the Centre.
In early November, Goldman Sachs wrote that the macro challenges India faces in terms of external and fiscal imbalances, high inflation and tight monetary policy are being dominated by expectations of political change, specifically that the BJP-led National Democratic Alliance (NDA) could prevail in the next parliamentary elections that are due by May 2014. After the exit polls, Merrill Lynch observed, The market is looking for a strong, stable government post 2014 elections and it seems that these results will likely make the market think that BJP could emerge as the lead party in the 2014 elections.
Much of the rally has been psychological. Despite no sign of investments picking up meaningfully, the BSE capital goods index has been a big gainer in anticipation of the new government being able to spur investments. The BSE Bankex a proxy play on the economy too has done fairly well at a time when interest rates are headed up and theres no indication whatsoever that loan growth is gathering pace. Indeed, corporate results for the three months to September have just about met expectations with many companies turning in disappointing numbers but the markets have shrugged off this very mediocre performance which was driven to a large extent by a depreciating currency and have almost ignored the fact that an early festive season boosted sales.
These are the first set of state elections since Modi was chosen the BJPs prime ministerial candidate for the 2014 Lok Sabha elections in mid-September. The market of course is aware that electoral success in the states of MP, Rajasthan, Chhattisgarh and Delhi which account for 13% of the seats in Parliament doesnt necessarily translate into wins here in a Lok Sabha election. However, as Merrill Lynch points out in six of the last seven elections, investors buying six months before elections and selling on the day before results would have seen positive returns with the average at 15%.