UP elections: The good, bad and ugly effects on markets

Just a week ahead of the monetary policy on 15 March and the annual Budget a day after that, the election results were certainly not just a political event.

The Congress’s poor showing in Uttar Pradesh upset investors: on Tuesday, the Sensex shed 500 points from the day’s high before closing at 17,173, down 1 percent.

The expectations were that the Samajwadi Party (SP) would at least seek the support of Congress to form a government in UP. However, as things stand now, Congress will be unable to bank on SP support at the central government level. With the BJP victorious in Punjab and Goa, the prospect of mid-term polls is also looming.

A Morgan Stanley report, however, notes that Mayawati’s Bahujan Samaj Party, after being routed in UP, might support the Congress to avoid Lok Sabha polls in the state. That might lend some support to Congress, but still does not make the Congress-led UPA strong enough to push through desperately needed reforms.

Opinion is divided on whether there will be big-bang reforms in the Budget or after. Some key bills pending in parliament are foreign direct investment in multi-brand retail and insurance, the Land Acquisition Bill, Mining Bill and the Food Security Bill.

Apart from that, there are structural reforms hanging in the balance, such as power and infrastructure sector reforms.

Goldman Sachs, in their analysis of the elections, is pessimistic about any of these taking off. “We think the results will not provide the political space for the government or the confidence to carry through unpopular reforms,” it said in a note. " The weakening of the Congress and better outcome for the BJP in the polls will see stormy Parliamentary sessions and Bills will take much more time and effort to be passed."

However, Morgan Stanley and UBS think that since Lok Sabha polls are still 24 months away, the government could seize this opportunity to undertake reforms aggressively. In fact, it might be able to balance its finances better, said UBS. “The government sacrificing fiscal consolidation (with a populist budget) to regain political support is also unlikely as resultant higher inflation is arguably a worse political economy scenario,” it said.

Citi made another point: the strong showing BJP in the elections could actually encourage the markets to become more upbeat about the 2014 elections, since the BJP-led coalition has a better history of economic reforms (it was in power between 1999 and 2004) than the Congress.

So what do the markets make of the election results? A day after the election results were declared, the Sensex was down 50 points; most experts believe the index could stay range-bound in the near term. The next big event to watch out for will be the Union Budget.

Major reform measures and the passing of several bills look unlikely.

For now, the situation seems glum.