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At the beginning of the year, we published an article that looked at the relationship between the stock market and the economy. As the pandemic devastated the Indian economy, the markets seemed conspicuously unaffected. In fact, the period after April 2020 saw one of the biggest market rallies in recent history. How could this be possible?

In our January article, we explained that the reason for this has to do with what the stock market represents. The prices listed on the indices are not a reflection of the current state of the economy, but rather an expectation of what the future will likely hold. As a result, if the market is rallying, it is because investors believe the future will be bright. Fast-forward 9 months and a quick look at the state of the Indian economy will lead any observer to conclude that not much has changed, and yet, the market continues to rally.

The unemployment rate currently stands at nearly 10%. This is not purely a result of the pandemic but is rather the outcome of at least a few years of poor economic policy making and growth. Earlier this year, Bangladesh surpassed India in terms of per capita earnings, with the average Bangladeshi earning nearly $300 more than the average Indian, for the financial year 2021. It was recently reported that India’s GDP growth for the first quarter was in excess of 20%. While this looks impressive, all it means is that it is 20% higher than the first quarter of the previous financial year, when the economy had contracted by 24.1%. In real terms, GDP has been declining since 2017, shortly after demonetisation.

All these facts paint a dull picture of the Indian economy. There is little that is being done at the policy level that would give people hope of an improved future. At the same time, Sensex and Nifty are soaring. Both indices have grown by 21% and 23% respectively since the start of the year. This is in stark contrast to the figures presented in the previous paragraph, so how do we explain this?

Sectors that are performing well. And Why?

First we need to look at which sectors have been doing well. With respect to 2021 specifically, the top 5 performing sectors are 1) Metal, 2) IT, 3) Realty, 4) Power, and 5) Healthcare. The fact that IT and healthcare are on this list should be self-explanatory. The pandemic forced people to stay at home which resulted in an increased use of technology, be it for work or entertainment. Healthcare’s rise is another result of COVID-19. People have become more health-conscious and as such are spending more on a healthier lifestyle. Of course, there are those who have had to spend due to a lack of choice, as a result of either being affected by the virus or some other illness.

One of the positives of this government has been their investment into infrastructure projects and the rate of completion of the same. They have surpassed the previous government on this metric. With such spending, it should come as no surprise as to why the metal sector has been performing so well. India is currently the world’s 2nd largest crude steel producer, and with China recently deciding to slow down its production owing to environmental concerns, India’s exports have also improved.

It might be perplexing to many as to how realty has been doing so well. Even analysts are unsure. One explanation might be the lower interest rates that are currently available, but it still doesn’t explain the situation. The realty sector has issues with debt and going forward, interest rates will begin to rise. Therefore, it might be wise to expect some volatility. If a third wave were to come along and another lockdown is to be imposed, then the sector will once again take a big hit. It might also be true that the sector is ramping up production now to make up for lost time.

The success of the power sector is something that has been built over the years, and is not a consequence of any recent events. India is currently the fourth largest energy consumer and is expected to consume nearly a quarter of all the energy consumed in the world by 2040. The sector has also undergone several reforms over the years with the allowance of 100% FDI by the government being the most recent of these reforms.

Where is money flowing from?

Yet, for these sectors to do well, people still have to invest in the stock market. Given the current scenario with the economy, it may still be confusing as to where this money is coming from. Lets look at the auto sector, for example. Two-Wheeler’s make up the bulk of the sales in the automobile industry, and sales have declined even beyond the pre-pandemic levels. In fact, sales across the industry have declined sharply since 2018-19.

Vehicle sales are one of the key indicators of how well the average Indian consumer is doing. With sales falling year-on-year, the obvious conclusion to reach would be that Indian consumers are lacking disposable income.

This is not the only indication we have. Towards the end of June the RBI released data regarding household savings in India. It found that the net financial assets had dropped for two consecutive quarters. The total number of loans taken out had also dropped from 5.4% in the previous quarter to 4.6% in this quarter. Household savings were already falling due to demonetisation and the GST, and the pandemic certainly didn’t help the situation.

This has been accompanied by, however, an increase in the retail participation in the stock markets. People have shifted some of the their earnings into mutual funds, and millennials seem to be more willing to invest in the markets than previous generations, which is a trend that will continue to rise. The low interest rates are also a contributing factor.

India VIX, which is an index that measures the level of volatility in the Indian markets, has been remarkably stable over the last one year. What this means is that investors are not phased by factors that would normally cause them to pull out their money. This lack of fear breeds confidence across the market, which encourages more people to invest. 

Since the beginning of May, the value of the VIX has been steadily dropping from around 23-24 to where it is now, which is 14.09 as of the 13th of September. To put this into context, the 52-week average is 29.64 which is well below the threshold of what is considered to be high volatility, which is anything above 35.

Having said that, stock market participation in India still remains well behind the developed world. Only around 5% of the population has funds invested in the exchanges, whereas in countries like the US, China, UK, etc. the figures are between 10 and 20%. The performance of the stock market in India is therefore always attributed to just a very small group of wealthy people who invest. This is further compounded by the fact that 2021 has seen massive inflows by foreign portfolio investors. In just the first six months, overseas investors have poured in more than Rs. 60,000 crores into the Indian markets. The data serves to exacerbate the fact that profits on Indian stock exchanges are booked firstly by a small investing community, and secondly this community often times is made up of investors from different parts of the world. This makes the disconnect between the prosperity of Indians and that of the markets even more evident.  

Whats more is that in this particular case i.e, the rally of 2021, the rise has been accompanied by record breaking export numbers. What this means is that a large part of the sales that these companies are making are not domestic and therefore are not being consumed by Indians.

For feedback, write to pavan@bclindia.in

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