Does the Stock Market lead the Indian economy?

A question that many people have regarding the country’s economy is the impact of the Stock market on it. After all, the ‘economy’, commonly viewed through the prism of GDP growth, sometimes seems to be moving in a quite different direction than the market.

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In reality, it is important to understand that the ‘Market’ is also something we view through a narrow prism – typically the market performance of the 30 companies that comprise the BSE Sensex or the 50 companies in the NSE Nifty. And while the performance of these companies does reflect the movements in stock prices, it is important to remember that the price of a stock has everything to do with investor expectations about future performance and the company’s actual, present-day performance is only a small factor in it. To illustrate this, let us remember that from the period 2009-2013, the US Stock markets continuously rose, following the crash of 2008 with a sustained rally. But it was not until 2012 that the real economy, meaning jobs and wealth, actually began to grow.

In the Indian context as well, it was a not dissimilar story. Market fluctuations have often had little bearing on real-world happenings. For instance, the great rally of early 2014 had everything to do with investor sentiment and irrational optimism about the imminent rise of the pro-development Government, and little relation to the fact that on the ground, the systemic problems that had led to the decline in the markets had not changed.

Presently, most economists see the stock market as a useful predictive tool, rather than a factor causing long-term effects in the real economy. And as anyone would tell you, both at the optimistic and the pessimistic end of the scale, stock markets tend to overstate things. Not every Stock Market crash is a harbinger of recession, and not every rally indicates a return of good times.

Let us consider the actual effects that Stock Market movements do have on the Indian economy in brief:

1. Wealth erosion : The first and most obvious impact is that those whose money is invested in shares and equity-oriented mutual funds will see a decline in their wealth. Given the size of the Indian stock market (which peaked at 100 lakh crores in 2014), even a 1% fluctuation leads to a significant change in the value of individual’s stock holding.

2. Pension / Retirement funds : While at a lesser level than foreign counterparts, some part of the retirement funds of Indian employees are tired up in the stock market. The New Pension Scheme (NPS) in particular, is linked to market equities, as are many of the pension funds that we invest in through insurance companies. Obviously, an erosion in the stock market leads to a decline in this value as well.

3. Confidence : As stated before, the Stock Market is an indicator of the confidence investors have in the market. The Indian stock market is particularly sensitive to foreign investor funds, and hence the rise and fall of the market shows fairly accurately how foreign investors perceive the prospects of the Indian economy.

4. Investment : A declining share price impacts a company’s ability to raise funds, not just from the stock market (obviously any fresh issue of shares would be at a lower price), but even lenders tend to stay away from a company whose stock is on a decline

5. Short-term corporate memories : With so many executive-level bonuses and incentives tied to the stock market, a fluctuating stock market leads to equally short-term decisions being taken. Reckless cost-cutting and employee lay-offs have been resorted to for no other reason than to shore up a stock price.

In conclusion, we can drawn an inference that while the stock market, as a component of the economy, has a significant impact, but given its own fluctuating nature, it tends to be short-term rather than long-term.

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