Indian stocks volatility index shows election fears

The National Stock Exchange's India Volatility Index , which measures the expectation of near-term volatility based on index option pricing, has jumped 22.3 percent so far in May, while the more widely known U.S. CBOE Volatility Index .VIX eased 8.4 percent this month up to Thursday.

The Indian stock market has recovered about 50 percent of its value from 2009 lows hit in early March, swept up by a wave of investor optimism on increasing confidence the global economy is on the mend.

But political uncertainties could play spoilsport if month-long national elections produce a fractured mandate when results are released on May 16.

"We are facing an event that the world is not facing, and that is fuelling the volatility," Hemant Thukral, vice president at Asian Markets Securities, said. "Things will continue to be erratic in the near term because the event is so big."

The world's largest democracy went to polls last month, with the ruling centre-left Congress party coalition seen having a faint edge over a rival group led by Hindu-nationalist Bharatiya Janata Party (BJP).

Neither of the parties is expected to win an outright majority, and the focus will be on possible coalition partners.

A tight race across India has sparked fears of a weak coalition government that could delay pro-market reforms as the country grapples with the global economic crisis and security issues.

Political instability worries following elections have hurt the stock market in the past, with the main BSE index .BSESN plunging as much as 16.6 percent on May 17, 2004, when the ruling BJP-led group suffered a shock defeat and the Congress party forged an alliance with the communists.

In 1999, after rising rapidly in the months ahead of the general election, the market then eked out gains of just 0.1 percent in the following month.

"It appears that a government which is perceived to be stable has a positive impact on activity," Goldman Sachs analyst Tushar Poddar said in a recent note.

"The two elections in which activity declined were when neither of the two major national parties -- the BJP or Congress -- were a part of the ruling coalition," he said.

Apart from political risk, other factors seem to bode well for the stock market. Economic growth is widely expected to pick up later this year, while some valuations are still cheap and foreign funds appear eager to invest.

Foreign funds moved $1.5 billion into Indian stocks in April and $655 million in the first four days this week, but that could quickly reverse in the face of political instability, analysts said.

"If we have a weak coalition, there are going to be questions about how long the government will last and if there is going to be a lot of fighting between the various factions," said Sanjeev Prasad, co-head of institutional equities at Kotak Securities.

"But the government needs to be concentrating on improving India's fiscal situation for the market to recover."