How Government Policies affect the Stock Market?

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Before investing in the stock market, no investors think about how government policies can affect his investments.   

As investment in the stock market has increased, people have started asking why and how government policies affect the stock market.

The best example of how government policies affect the stock market is the day the government announces its budget. The announcement of various government policies, programs, investments and expenses not only affect the stock market of that country but it can affect the stock market of other countries too.

The change in tax rates, interest rates, government expending (capital expending or revenue expending) all are the important determinants of the stock price.

Apart from the budget announcement, central government, state governments and central bank bring various policies related to industries, trade, economy etc., throughout the year, which also have a big impact on the stock price.  

Related: Why Investors Lose Money in the Stock Market?

Many times it happens that when the government changes its policies, it hurts the business of many companies, on the other hand, it is positive for the business of some companies.

As soon as government policies come in, the companies whose business has a negative impact, the stock prices of those companies fall immediately. In the same way, the stock prices of the companies whose government policies are helpful, start increasing immediately.

For example, if government policies focus on infrastructure, then the stock prices of cement, steel, infrastructure companies increase. Similarly, if the government increases taxes on tobacco, cigarettes, liquor, or imposes restrictions on them, then the stock prices of these companies fall.

1. How changes in the tax rate affect the stock price?

The tax rate is one of the most important determinants in the stock market. The change in tax rates has a direct impact on the share prices of companies.

For example, if the government lowers the tax rate, the corporate net profit increases. This additional benefit can either be used to distribute to shareholders or can be used by companies for further investment.

If the corporates distribute their additional profits to the shareholders or invest elsewhere, the shareholders of the company will benefit in both the cases. The share price of the company will increase automatically as the shareholders gain.

On the contrary, if the tax rate increases, then the profits of the investors along with the company also fall. Investors also have to pay more tax on their profits. By paying more tax, investors get very little return from their investments, due to which they make a distance from the stock market. The risk is already high, but the return has been reduced, so investors especially foreign investors start withdrawing their money and start investing there where the tax rate is low.

2. How the stock market is affected by interest rates?

One of the factors affecting the stock price is the interest rate. Nowadays almost every business, operate with some borrowings from banks and financial institutions, on which they have to pay interest.

If the interest rate increases, then the corporates have to pay more interest on their loan, which reduces their profits. Due to low profits, their stock price is negatively affected and their stock prices fall. Similarly, if the interest rate is low, then the corporates have to pay less interest on their loan, which increases their profit. The increase in profit of corporates has a positive effect on their stock price, due to which the stock price increases.

3. How political uncertainties affect the stock price?

Political stability is very important for an economy and the stock market. If there is uncertainty in the political situation in a country, then neither there can be development nor there can be any government policies for the public interest. Stability in government tends to increase the growth of the economy.

Whenever a new government comes, it brings new policies as per its election promise. Due to the policies of the new government, some industries benefit and some industries lose. Due to the new policies, there is a lot of change in the returns of the portfolio of long-term investors.

It is most commonly thought that is the political system in any country is uncertain then investors will remain under fear of losing their wealth.

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