The political developments in any given country affect its overall wellbeing. The effects of politics apply to all sectors, including the financial services industry.
There are many ways in which a country’s political climate affects its finance sector. The most important such factors have to do with changes in leadership — elections and revolutions. There is also direct policy-making on behalf of the government that regulates the sector. Understanding each factor individually will help you gain a better idea of how politics impact finance.
“Elections are arguably the most obvious way in which politics can affect the financial sector. Whenever there is a change of power, the markets await the results with bated breath. The markets anticipate the results because the political leaders of any country inspire a different degree of trust among investors.” says Jan Ostram, financial analyst at Sambla.
For instance, when a presidential candidate is seen as forward-thinking and is well-liked, their election has a favorable impact on the financial markets. Conversely, when someone controversial comes into office, there is a negative reaction.
These reactions occur because the markets move in line with the general economic trend in a country. Even when they’re not directly regulated by the President or Prime Minister, the markets are sensitive to political talk. For example, say a populist candidate wants to increase government spending on welfare. This move will decrease the value of the nation’s currency due to fears of higher inflation.
Revolutions are important for reasons akin to elections: they represent a change in government. However, unlike elections, which are a normal part of any democracy, revolutions happen suddenly and take the country by storm. Because of this, their impact tends to be more dramatic.
The country is likely to experience an economic downturn during the transition, especially if there is civil war. However, revolutions occur on the promise that things will take off once the dust settles. That’s why they can also lead to optimism among investors.
The difference in the economic growth of capitalist countries versus the USSR in the second half of the 20th century is proof enough that ideology matters. The Soviet Union was an example of totalitarianism: the government owned and controlled everything. The national currencies of Soviet countries were under tight government regulation.
On the other hand, in the capitalist west, the markets are by default free of regulation, unless absolutely necessary. The value of these countries’ currencies is based on the actual economic climate, without the government’s manipulation.
Politicians can also reshape the financial sector of a country through policy-making. The government decides on a budget for each fiscal year. They can also pass new laws that affect the financial sector. For instance, the government may ask for lower ceilings on annual interest rates in order to reduce predatory lending.
In addition, central banks all over the world constantly keep an eye on inflation and unemployment rates. If they sense a recession coming, they will lower interest rates to contain the possible damage. Slashing interest rates has a direct impact on money lending.
The Bottom Line
Economics and politics have a very close relationship. If you are active in the financial markets, you need to pay attention to politics. Watch out for changes in government and central bank policy decisions in particular.