IMF Finds Election Uncertainty Drives 28% Capital Inflow Decline; Strong Institutions Mitigate Risk
SDG 16: Peace, Justice, and Strong Institutions | SDG 8: Decent Work and Economic Growth
Institutions: Ministry of Finance | Reserve Bank of India (RBI)
The IMF Working Paper, “Elections Matter: Capital Flows and Political Cycles” (WP/25/243), investigates the impact of political uncertainty, proxied by elections, on international capital flows to 38 emerging market economies (EMEs). The study finds that gross private capital inflows decline significantly during election quarters, with the negative effects persisting for up to two post-election quarters. This volatility is a critical problem as EMEs rely on these inflows for economic stability and growth.
The impact is highly heterogeneous and dependent on domestic stability. In countries with low political stability, capital inflows decline by an average of 28% during election quarters. This effect is larger and more persistent in high-uncertainty elections, such as those marred by violence or resulting in an incumbent’s loss, where the decline can reach 50%. Notably, Foreign Direct Investment (FDI) and other long-term investment flows are found to be more sensitive to this uncertainty than more liquid portfolio flows.
The report’s central finding is that these adverse effects are significantly mitigated by strong governance and institutional quality. Structural reforms that strengthen the rule of law, regulatory quality, and control of corruption are essential to bolster investor confidence, reduce uncertainty, and enhance financial resilience during political cycles.
This research is critical for India, as it confirms that political uncertainty is a systemic financial risk. The primary policy imperative is to enhance institutional quality—strengthening the rule of law and regulatory predictability—as this is the most effective tool to mitigate capital flow volatility during India’s frequent election cycles.
What is the significance of FDI and “other investment flows” being more sensitive than portfolio flows? → The paper notes FDI and other investment flows are more sensitive to election uncertainty than portfolio flows. This is a critical finding because FDI (Foreign Direct Investment) is long-term, “sticky” capital (like building a factory) that signals deep investor confidence. A decline in FDI suggests that political uncertainty is not just scaring off short-term market traders, but is also forcing long-term strategic investors to delay or cancel essential projects, which has a much more damaging and persistent effect on economic growth and job creation.
Follow the full report here: Elections Matter: Capital Flows and Political Cycles