Column: Elections wont trigger revival

Written by Neelkanth | Neelkanth Mishra | Updated: Dec 12 2013, 10:34am hrs
As the dust settles around the state election results and the media hyperboles surrounding them, it is time to take stock of how they impact the economy and earnings. Given that the four states of Madhya Pradesh, Rajasthan, Delhi and Chhattisgarh are together less than 15% of Indias GDP, any change in their growth trajectory brought about by the new governments is unlikely to have much nation-wide economic impact. The stock markets enthusiasm is instead related to the indications from these elections for the 2014 general elections and beyond.

But even there it is difficult to draw any conclusions, as these four states contribute only 13% of the Lok Sabha seats and house only 14% of the electorate. While a pro-BJP and an anti-Congress wave in the results cannot be denied, it would be premature and unwise to extrapolate these to the rest of the country.

In particular, the bipolar nature of the contests in three of these states effectively made every anti-Congress vote a pro-BJP vote. In the fourth, i.e. Delhi, leaders of the Aam Aadmi Party (AAP) have been active for over 10 years and provided a credible alternative. In 2014, in other states, where several regional parties are active and the contests arent merely between the Congress and the BJP, the arithmetic is likely to be much more complex. More so as all parties have been around for a while, so there is no perceptible forerunner. For example, in Uttar Pradesh how strong will be anti-incumbency for the SP, and will the voter swing to the BSP or the BJP How will the fortunes of the RJD and the JD(U) change in Bihar, and can the BJP step into the vacuum The answers to these questions will make all the difference in 2014, and last Sundays results provide no indications.

But these results do show several positive trends.

Firstly, across the four states, there was clear consolidation of votes: voters are learning to adjust to the first past the post system, and learning not to waste their vote. While the Congress may have lost seats, its vote share increased in Madhya Pradesh and Chhattisgarh. In Rajasthan, its vote share fell 4%, but that of other parties fell much more, and even the Congress polled more votes in 2013 than it did in 2008. This is the continuation of a trend seen in states like Uttar Pradesh where, despite quadrangular contests that earlier used to throw up unstable coalitions, the electorate has given clear verdicts in the last two assembly elections.

Secondly, and most importantly, whatever be the underlying economic philosophies of the AAP, their electoral success is a turning point in Indian politics possibly as important as 1989. Back then every political party was forced to respond to the politics of caste and religious identity, and a new crop of leaders emerged. The AAPs success is likely to improve standards of public probity and transparency across parties, though the change may be a lot slower than one hopes for.

But all said the stock market implications of these changes are limited. The market only worries about surprises to growth and earnings over the next two to three years at most. And general elections have a lot less impact on this than popularly believed. Historically, there has been no correlation between economic growth and fragmentation of a government (i.e. if it is a single party government or a ragtag coalition), or its colour (i.e. is the left-front part of the government Is it led by a party with a strong swadeshi ideology). There are three main reasons for this.

The first is that given the size of the country and the government, and in particular the complexity of regulations, change management is difficult and takes time: historically, it takes six to eight years for reforms to move from intent to meaningful impact on growth or job creation. Even landmark changes like the VAT and national highways development took as long.

The second is that state governments matter more for growth than the central government, and particularly now. As per the Constitution, critical subjects like land, law and order, state highways, and electricity distribution, to name a few, are all under the state jurisdiction. The central government is mostly in a policy-making role. One need only look at the wide divergence in state GDP (SGDP) growth over the past two decades to understand the difference state governments can make. This is not to say the central government doesnt matter, just that they are one of several variables driving growth.

And thirdly, the rhythm of reforms in India is very different from political cycles, likely because no political party wins votes on an economic plank. In a perverse way, this is positive, as it frees them to do what is necessary when they form the government. The phrase no room for complacency appeared in every budget speech from 1991 to 2003, a period that saw a Congress government, a Third Front government and then an NDA government.

The phrase disappeared between 2004 and 2011 (i.e. the government became complacent) but reappeared in 2012 and 2013. Major reforms are already under way, even if by stealth, like steady privatisation of the banking system (government-owned banks losing share), and opening up of trade barriers (numerous free-trade agreements).

The current rally in large-scale investment focused stocksindustrials, banks and metalsis due to the confluence of three forces. First, the wide divergence in stock market multiples causes the vertigo of possibility for fund managers, i.e. what if the beaten down stocks suddenly rebound and the outperforming stocks disappoint Second, continuing inflow of foreign institutional capital, which forces some churn in the market. And third, a hook to hang hopes from (in this case political), ignoring the current weak state of the investment ecosystem.

Irrespective of the election outcome in 2014, the economic cycle is unlikely to change meaningfully in the coming 2-3 years, and investors are best advised to consider the current rally in high-beta stocks a trading rally rather than one to change core portfolios.

The author is Credit Suisse India equity strategist