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Understanding the Impact of Government Policies on the Indian Stock Market

Welcome to the wild and wacky world of the Indian stock market! This is the place to be if you’re looking for an exciting and unpredictable ride. Like the unpredictable plot twists in a Bollywood movie, the stock market can be a roller coaster of emotions. But have you ever wondered how government policies can affect the stock market?

Buckle up, and let’s understand the factors affecting the stock market in India!

How do government policies affect the stock market?

If the government announces a new policy that will increase taxes for a particular industry, investors in that industry may panic. This will result in a sell-off, leading to a drop in stock prices. 

On the other hand, if the government announces a policy that will stimulate economic growth, such as a new infrastructure project, investors may become more optimistic, leading to a rise in stock prices.

What government policies impact the market?

Just like how various characters in a Bollywood movie can impact the plot, several government policies can have a significant impact on the stock market, including:

  • Monetary policy: The Reserve Bank of India (RBI) uses monetary policy to control the money supply in the economy. For example, if the RBI lowers interest rates, it makes it easier for companies to borrow money and invest, leading to increased economic growth and a rise in stock prices.

Impact of repo rate on the stock market

This is precisely why in 2022, the RBI introduced several rate hikes to tackle inflation. As of February 2023, the apex bank announced a rate hike of 25 bps, increasing the repo rate to 6.50 per cent. The US Federal Reserve also followed a similar approach. 

  • Fiscal policy: The government can also impact the stock market through its fiscal policy, which involves government spending and taxation. For example, if the government announces a new infrastructure project, it can increase economic growth and stock prices.

Ultimately, the aim of fiscal policies is to reduce the fiscal deficit i.e., the difference between the government’s revenue and expenditure. Higher the fiscal deficit (in negative), the higher the government debt. 

  • Regulations: The government can also impact the stock market through regulations, just like how a side character in a Bollywood movie can significantly impact the plot. For example, if the government announces new regulations for a particular industry, it can impact the financial performance of companies in that industry, leading to a rise or fall in stock prices.

Remember, during the COVID-19 pandemic, India imposed a nationwide lockdown, restricting all possible movement except for essential services. This “regulation” disrupted the functioning of large corporates, prompting them to go online. However, this disruption impacted their profit and, invariably, their stock prices. 

How does the budget affect the stock market?

Like the Bollywood movie’s climax, a country’s budget explains how it will spend money in the foreseeable year. Being a major event,  there is no doubt that the budget can impact the stock market. 

Let’s consider the example of Budget 2023, announced by Finance Minister Nirmala Sitharaman on February 01. 

Post announcement – 

  • Nifty 50, the stock index of NSE, rose 1.55 per cent to 17,936.60. BSE index  Sensex rose 1.75 per cent to 60,594.46. Why? Because the budget brought some positive changes to the current income tax regime. This is likely to reduce taxable income and boost consumer spending. 
  • With consumer spending increased, bank products like loans, credit cards, debit cards, etc., are likely to increase. Thus, bank stocks such as ICICI Bank (3 per cent) also soared. 
  • On the other hand, ITC shares fell after the announcement. Why? Because ITC is one of the largest cigarette manufacturers in India. The government decided to increase the charges/duties levied on cigarettes. 

These are just a few examples of how budget 2023 impacted Dalal Street. But they are enough to prove that budget impacts the stock market

How do Elections Affect the Stock Market?

Usually, as per logic, if a pro-business political party wins an election, investors may become more optimistic, leading to a rise in stock prices. On the other hand, if a political party seen as anti-business wins an election, investors may become more pessimistic, leading to a drop in stock prices.

Take the case of the 2014 Assembly elections, when Narendra Modi was elected the country’s prime minister. As per a BusinessToday report, 

  • On the vote counting date (May 16, 2014), BSE Sensex surpassed the 25,000th mark for the first time., surging 1,470 points on intraday. 
  • NSE’s Nifty50 hiked and crossed the 7,500th mark for the first time. 
  • However, as the day passed and the outcome became evident, both indexes ended below their respective highs. 
  • Thus, the anticipation of the election results caused more excitement among investors in comparison to the actual outcome. 

Do state elections impact the stock markets?

The short answer is yes. State elections can impact the stock markets. Think of it this way: if you’re investing in a company that operates in a particular state, and that state’s political landscape changes, it can have a direct effect on the company’s profits and, in turn, its stock price. 

Another example could be if a state elects a pro-business government, it could mean more investment and growth opportunities for companies operating there. On the other hand, if a state elects a government that is anti-business, it could mean more regulations and restrictions for companies, leading to a drop in their stock prices.

Do stocks go up when earnings are released?

Earnings releases can be like opening a present on Christmas morning. Sometimes you get a shiny new toy, and sometimes you get a pair of socks. If a company releases earnings that beat expectations, its stock price can go up. On the other hand, if a company releases earnings that miss expectations, its stock price can go down. 

Remember in 2022, when the companies were announcing their Q3 results? At that point, the banking sector performed the best amid inflation and geopolitical tensions. And hence, banking stocks were soaring on both BSE and NSE.. 

How does monetary policy affect the stock market?

Monetary policy refers to the actions taken by the central bank, in this case, the Reserve Bank of India (RBI), to control the money supply and interest rates in the economy. These actions have a direct impact on the stock market. Why? Because changes in interest rates can affect consumer and business spending and, in turn, corporate profits. 

Due to rising inflation, US Fed and RBI are hiking their interest rates. Such hikes are a part of their monetary policy to control inflation. So, economic growth is currently taking a backseat. 

How inflation affects the stock market?

In layman’s terms, inflation refers to the rise in prices of goods and services over time. Inflation alone is merely an indicator of price rise. What worries a country is when inflation rises rapidly within a short span. 

If inflation is high, it can eat into corporate profits and lead to lower stock prices. On the other hand, low inflation can boost consumer and business confidence, leading to more spending. And as the logic goes, the more the spending, the higher the corporate profits. As a result, stock prices go up. 

Auto data and its impact on the stock market

Have you ever noticed that whenever the auto sales data is released, the stocks of auto companies go up or down like a roller coaster? It’s true the auto industry has a direct impact on the stock market and vice versa. 

Imagine you’re on a road trip, and suddenly your car breaks down, leaving you stranded on the side of the road. That’s exactly what happens to the stock market when auto sales go down. The stock market gets stranded, and all the auto stocks lose value.

But why does this happen? It’s simple. The auto industry is a crucial part of the economy, and a decrease in auto sales is often considered as a sign of a slowing economy. And when the economy slows down, the stock market also feels the pinch.

On the other hand, when auto sales go up, it’s a sign that the economy is picking up speed and the stock market revs its engine. So, the next time you hear about auto sales data, remember that it can be a key indicator of the stock market’s health.

How geopolitics affects the stock market?

Geopolitical events have the power to turn the stock market into a battlefield. Wars, natural disasters, trade tensions, and other geopolitical events can all impact the stock market in unpredictable ways.

Case in point – the Russia-Ukraine conflict shaped a cold war-like situation. Countries had to choose sides, and those siding with Ukraine had to redraw their supply chains. Because Russia is a leading oil exporter.

With Russia out of the picture and limited supply, oil prices soared. And thus, oil stocks plunged. Of course, such a conflict impacted other sectors as well. And thus, for quite some time, the Indian stock market remained in the red. 

Quantifying the geopolitical risk is challenging, but it’s essential to keep an eye on these events. Why? Because they have the potential to create massive waves in the stock market.

FAQs

Why is the stock market important to economic growth?

The stock market is one of the key contributors to public companies raising the required capital for their operations.  Capital raised from the stock market affects the company’s revenue, employment opportunities, etc., directly impacting the economy.

How does recession affect the stock market in India?

Economic recessions most often lead to unemployment, affecting people’s lifestyles. They compromise on their needs, which hits the demand for certain products. This affects the stock’s prices. Also, investors save money for emergencies rather than investing in the stock market during a recession. So, the market is usually negative.

What happens to stock prices during the economic cycle?

Certain stocks follow the same cycle of the economy. These stocks are called cyclical stocks. Their prices increase when the economy is flourishing. Their prices decrease when the economy is downtrending. For example, stocks of companies producing luxury goods react based on the economy.

What stocks go up in a recession?

Some stocks remain stable or even grow sometimes, despite economic conditions. These are opposite to cyclical stocks and are called defensive stocks. Companies that provide goods and services that meet the basic needs of consumers fall under this category. Fast-moving consumer goods (FMCG), pharma, etc., are examples of defensive stocks.

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