IMA Analysis

Monday December 16, 2019

Swells like the Solway but Ebbs like its Tide

Author: Adit Jain, Editorial Director, IMA India


Over the last few weeks, the stock markets have made an astonishing reversal with the Bombay Stock Exchange’s Sensitive Share Index setting fresh records even as the overall economy remains subdued. Both investment and consumption have yet to perk up and it is logical to wonder as to why this is happening. Some would argue that the markets are generally accurate at reading into the future and they therefore expect the industrial economy to perform better over the coming 12 months. On the ground, however, businesses have a different tale to offer with the burden of rising inventories, falling orders and shrinking margins. Whilst it is possible that a consumption recovery may yet begin in 4-6 months, the indications of this are currently few.

One reason the equity markets may be frothing is because of some misgivings about the fixed income side. Perhaps, this is prompting a greater willingness for new investors to target equities. Second, the savings rate continues to remain steady largely a happy consequence of a drop in consumption. Therefore, larger sums now chase fewer stocks. As an example, net equity investments by mutual funds jumped from Rs 67.9 billion in the April-June quarter to Rs 435.2 billion in the next. An analysis of investment patterns would suggest that the greater demand remains in the large cap segment, which constitutes the basis of the headline indices. The demand in other areas such as mid and small caps is muted. This is reflected in their returns – the Sensex boasts of a 15.5% yield on a 12-month basis against -0.2% and -6.6% in the mid and small cap segments, respectively. Third, the unexpected corporate tax cut would result in strong book profits for business enterprises, and investors therefore expect higher dividends. But none of this would suggest that the real ailments affecting the economy – weak consumption and consequently new investment – are about to reverse in a hurry.

Be that as it may, in the longer term, there is substantial evidence to suggest that buoyant markets do drive the economy as a consequence of liquidity and, more importantly, the wealth effect phenomenon. When people feel happy about a rise in their notional wealth, they are more likely to indulge in discretionary spending such as on home appliances, holidays, cars and motorcycles. Clearly such things have a lag effect and it is hard to say when consumption will respond but, if the stock market run were to continue, we should see an impact over 6-12 months. Another concern that affects the industrial economy, specifically real estate, is the absence of liquidity and credit. NBFCs and mutual funds, which provided the main lines of funding, have become cautious and are unlikely to change tack in a hurry. Moreover, the problems that plague the banking system will continue to dampen credit flows that are essential for growth, consumption and investment.

Foreign institutional capital, which had made a hasty retreat a few months ago, has finally begun to reverse course. The data available until October clearly indicates net positions in the black. A global slowdown, across advanced economies and China, could make India seem relatively more attractive. In the final count, markets expect a bold reform thrust taking place over the coming months. Judging by the Government’s recent moves, for instance the cut in corporation tax, the induction of fresh capital into the banking system and the introduction of a Rs 25,000 investment fund for distressed real estate assets, punters believe further pump priming measures would take place. There are also murmurings of a rise in import duties so as to favourably persuade domestic manufacturing. There is a school of thought that suggests that trade is a substitute for investment. If the Government were to fulfil a few of these expectations, the markets may yet continue to swell and eventually so might the economy.