IMA Analysis

Tuesday September 24, 2019

Economy and Markets

Author:  Adit Jain,Editorial Director, IMA India

It’s the market that counts

When the markets went into a tizzy following the presentation of the budget earlier in the year, Finance Minister Nirmala Sitharaman put up a brave face. She shrugged off the hullabaloo, gracefully clarifying that market movements do not disturb her calm. But they should, as it is really the markets that drive the economy, rather than the other way around. Since February 2019, Rs 12 trillion of wealth has been wiped out, destroying investor sentiment. The industrial economy is on the cusp of a recession with several key sectors in various stages of contraction.

Manufacturing output dropped to 0.6% in Q1 (April-June) and lead indicators point to a series of painful quarters ahead. The sales of passenger vehicles crumbled by a monstrous 41% in August, whilst two wheelers and commercial vehicles slipped by 22% and 39% respectively. We have consequently felt it prudent to revise our growth forecast to 6% with risks on the downside, leading conceivably to further revisions in the months ahead. The economy is being driven solely by the services sector. Manufacturing, on the other hand, is bracing itself with grim job losses.

Foreign portfolio investors, losing confidence in India’s near term prospects, have understandably become jumpy leading to capital outflows at disturbing levels. Consequently, liquidity is bound to suffer and so will investment. The collapse in shareholder wealth has impacted consumption, reflected in what economists describe as the negative wealth effect phenomenon. Basically, when notional wealth drops, people do not feel good about their circumstances and curb discretionary consumption. This affects, most prominently, the sale of products and services that cost above Rs 10,000. Consumption data has supported this hypothesis. With a drop in consumption, industry has little appetite to create new capacities and even if it wanted to, there is little scant in capital markets to fund them.

Why has this happened? Basically it all began with the flow of credit and the absence of liqiuidity, badly impacted by a dysfunctional banking system and distressed shadow banks (NBFCs). The clean up requires some serious amount of fresh capital. With limited resources the government can hardly step in without affecting fiscal deficit targets. One way to fix the problem is to inject private capital, effectively privatising the banks, but this conflicts with the social ideology of most political parties in India. The fiscal deficit targets are already shaky, despite accounting for the huge pay-off to the treasury by the Reserve Bank of India. It would therefore be unfair to assume that the Government could initiate a quick fix, but what it could have done is to have inspired confidence in industry, which it lamentably failed to do. On the other hand, it undermined a shaky atmosphere with higher taxes especially on the rich and foreign portfolio investors. Both groups have consequently dumped their holdings and repatriated capital out of the country.

Over the course of the past 7 years Indian industry has invested large sums abroad. Over, 35,000 businessmen have migrated out to live in other countries in this period. Clearly, some of them may have done so to escape scrutiny and prosecution, but still others have moved in search of better opportunities elsewhere. This is an unfortunate reflection of their lack of confidence in their own country. It is the role of the treasury to bring this confidence back. The first step is to acknowledge the role of the markets and the fact that they drive the economy. Two days ago, Ms Sitharaman announced a series of tax measures, which propped up the markets suggesting that this principle may be finding acceptance. If that is the case, there are reasons to expect better times.


Adit Jain’s articles and opinions can be found on his blog at This content is the intellectual property of IMA India and is copyright protected and legally privileged. Unauthorised copying, reproduction or distribution of this information would amount to an infringement of law and would invite applicable penalties.