The disconnect between the stock markets and the Indian economy

Let’s say a friend of yours, has INR 50,000 and wants to own a business, hoping to make a lot of money over a period. He observed that with COVID 19, many companies offered work from home to their employees and therefore the need for laptops has increased. Now here, for someone to start a new company in this industry, they need government permissions, plant, property and equipment, raw materials, and hundreds of other resources. Not to mention, their investment of INR 50,000 is not enough to fetch them anything. So, they choose to invest the same in some other company which has already secured all the expertise and resources to manufacture the same. Now, this is where the stock market comes into the picture where one can choose to buy partial ownership of any company from the ones listed there. Due to the rising cases of COVID 19 cases, the whole world shifted to online platform to carry on with their work and thus, the demand of better computers and laptops increased. Manufacturing companies boosted their productions to meet the demand and earn profits from this opportunity. They employed more laborers, bought more raw materials, and invested in their research facilities to improve their process and increase their supply. In very simple terms, this is how the economy grows, as with increasing demand, the supply also started increasing. Businesses start making more profits and as a result, they invest more and hire more employees to expand. As employment increases, the buying capacity also improves. With more money in hand, consumers spend more to buy different comodities which creates more demand and this cycle goes on. This demand is capitalized by businesses and now their stock prices also rise.

So, here we might start thinking that, there is some relationship between the economy and the stock market. But whatever we understood till now, is just a partial truth or only the half picture. The rise and fall of stock markets is not just dependent on the economic position of the country. There are hundreds of other factors as well which play a very important role in it. Government policies, political scenarios, market sentiments, which unlike other factors, are purely emotional, etc are few major contributors to fluctuations of stock markets. Markets in the short term, are irrational and only in long term they are efficient and reflect true economic progress as measured by GDP growth over long periods. Try holding this thought for a while, as by the time we conclude this, everything will automatically start making more sense.

To understand the previous idea in a better way, let’s observe the performance of the Indian stock market from the beginning of 2020. Here we have a graph showing the NIFTY50 market index figures from January 2020.

Exhibit published on TradingView.com, October 31, 2020.

With the first case of COVID-19 in India, reported on 30th January 2020, the stock markets began to fall. As the country went into lockdown, the economic activities also reduced to a bare minimum. The GDP growth of the country contracted by 23.9% by the end of the first quarter. Around 41 lakh job losses were marked which increased the unemployment level to 27.1% by the end of April 2020. Both the stock market and the country’s economy took a hit and witnessed a steep fall.

But the stock market started to recover soon, as few companies emerged as Corona warriors for them. Starting with Reliance Industries Limited, the Adani Groups, Sun Pharma, Bharti Airtel, Vedanta Ltd., the Shiv Nadar Group, the Aditya Birla Groups, and the Radhakishan Damani Groups, clocked substantial market gains. Each company had a different reason for the sharp rise in their share prices. A few of the contributing factors were aggressive and successful fund-raising programs, the rally in pharmaceutical sectors amid the COVID pandemic, increase in data usage with the work from home policies of the companies, increase in the demand for health care products, increase in the usage of logistic services, etc.

At this point, the markets showed positive signs of recovery and started rising but the economic growth was still suffering. The GDP growth reported in the first quarter was 5% and in the second quarter it further slowed down to 4.5%. The MSME sector which contributed to more than 30% of the total GDP was still under great stress. Moreover, the India-China standoff situations at the borders added to its loss. The government banned imports from China and motivated the citizens to boycott all Chinese products. Mr. Nitin Gadkari Minister of Shipping and the Minister of Micro, Small and Medium Enterprises raised his concerns regarding the losses that the local businessmen who had already paid for the goods and raw materials, will have to bear. Not to mention the increase in the cost of production as we imported cheaper machinery, electrical, chemicals, and other raw materials from China, also impacted the supply and demand of many products thus impacting the economy.

Since all the international trade declined, therefore it became very difficult for the industries to maintain a low cost of goods sold. Also, all the capital-intensive sectors such as construction sectors and manufacturing sectors were still unable to recover, due to the huge shortage of laborers to carry out the operations. An increase in the job losses decreased the spending capacity of the majority populations which led to a decline in the demand. The sudden change in the spending behaviour of the masses also led to a huge liquidity crisis for the industries making it more challenging for them to continue their daily operations. Our banking sector is still trying to recover from the huge NPAs accumulated over the period.

So with all things said, it is very clear that contrary to popular belief, the economy and the stock market are two different things. Markets, many times, ignore the economic reality and works in their ways, which are not in sync with the economic principles, we know. Since the Great depression of 1929, stock markets have repeatedly shown that it has no link with economies or with business fundamentals. In one of the most famous books, ’The General Theory of Employment, Interest, and Money’, by economist John Maynard Keynes, the author talks about markets being governed by wild forces, whereas the economic growth being derived from the real productivity of the country. Probably this is the only way we can understand, how Nifty50 closed the calendar year 2019 with gains of about 12.0% whereas our GDP only grew by 5.024%.

– Shobhit Jain, Editor, TAPMI Journal of Economics and Finance

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