There are two main things it does:
First off, it will help seal a bond between you and the child. Children who are read stories or told stories are getting good quality time with you and they're well aware of it. Such attention works wonders as far as creating a stable, happy child.
Second, hearing your voice will aid in his development of good pronunciation and sentence structure, without the necessity of going into grammar. It's a good foundation for later building blocks.
Also, just reading a simple story and linking pictures to certain words, asking questions like what was you favorite part and why, can you show me when the monkey fell from the tree? Why do you think the monkey fell? Easy yet fun and interactive questions will help a child develop critical thought process like summarizing, self quesion, using text to prove answers, etc. These will come in quite handy in reading and writing later in life!! Have fun and read/tell a variety of genres!!
In addition to the other excellent answers, it also creates a desire to read. Children who are told stories want to read more. This is why so many libraries have story hours.
It's also one of the fundamental ways to help children understand this huge world into which they've been born. Even those scary Grimms Brothers fairy tales helped children deal with issues they faced in that time period.
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