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Stock market- Economy conundrum

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SENSEX-GDP Discrepancy has had many economists stretch their heads lately. People on the D-street are wondering why the stock market is buoyant amidst the economic slowdown. Why NIFTY and SENSEX are touching their all-time high while the economy is contracting quarter after quarter? 

There could be only three plausible reasons that could explain such an anomaly. 

REASON #1: Stock market indices no longer a reliable barometer for the economy. 

If we look at the SENSEX 30, we will find that it is no longer the correct yardstick to gauge the state of the entire economy. 

At present, SENSEX 30 mainly constitute companies from the following sectors: banking (like HDFC, Indusland, Axis), automobiles (M&M, Bajaj, Maruti), electricity (PowerGrid, NTPC) and conglomerates (like RIL, L&T, ITC).

It shows that the index does not give a complete picture of the economy as it outrightly overlooks the companies/industries that have been severely affected by COVID-19. 

Sectors like Travel & Tourism, Retail outlets, Multiplexes, Gem & Jewellery, agriculture, and Hotels & Catering, are not part of the index.

Let us assume for the sake of being upbeat that maybe, just maybe, few top blue-chip companies which are part of the index are doing good and contributing to the economy. 

However, this is not the case. In reality, out of 30 companies, half the companies last quarterly financial performance was either flat or negative.

In other words, it means that the market capitalisation of the other half is growing—or we should say inflating—just because of the irrational bullish behaviour of the investors, who hope that these companies will do good in the future.

REASON #2: Economic Stimulus worked

During both the Covid-19 waves, the Finance Ministry and the RBI aggressively injected liquidity into the economy via Atmanirbhar Package, PM Garib Kalyan Scheme, and various others relief measures are working.

India is not the only country that has announced such economic stimulus, the countries across the world have also launched various packages to revive their economies. As a result, their stock market indices have also been uprising since the first lockdown.

Just like the SENSEX 30 Index and NIFTY 50 (India), S&P 500 Index (U.S.), FTSE 100 Index (Europe), Nikkei 225 Index (Asian) are continuously rising.

It shows that the economic stimulus packages had been beneficial and helping to revive the economies around the world.

REASON #3: Economic bubble masquerading as economic revival 

Have we forgotten how the 2008 global financial crisis started? To revive the economy after the dot.com crisis, the U.S. Federal Reserve drastically cut down the repo rate and made it easier for everybody to take a loan. Yes, literally everybody—even people with no income or property—could take a loan at cheap rates. 

Consequently, it created a subprime mortgage problem because people who had poor credit scores took heavy loans and invested that amount in the properties.

Due to this, the housing prices started shooting through the roof and created the housing market bubble. Later on, the investment bankers tried to mitigate the financial risk using complex financial engineering but eventually failed. And, finally, the whole system collapsed when eventually the bubble burst.

Wait a minute! Where are we observing a somewhat similar phenomenon lately?

RBI has been cutting repo continuously since 2019, and now it is at its lowest, 4%. Moreover, India has also implemented Operation Twist—making long-term loans super cheap for the end consumers.

India is also not shying away from providing some financial to the businesses.

Ministry of Finance, under CGTMSE in the Atmanirbhar Bharat Package, providing liquidity to the financially weak MSMEs—who will most likely default on their loans in the future—of up to Rs. 3 Lakh Crores of the collateral-free loan with 100% sovereign guarantee. 

It means if any MSME defaults on the loan, the government will pay for it. No doubt, it will create a moral hazard problem.

So do you get the idea about where all this is going?

All of this is creating an economic bubble, which will burst eventually. And it will burst hard.

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