Mismatch between stock market and real economy

With GDP numbers plunging on one hand and equity markets soaring to new heights on the other, fears are developing over a K-shaped recovery that favours wealthy, with upper fork of letter “K” being the stock market and lower fork is the real economy, and the two being clearly divorced from each other. However, a well-directed financial stimulus can go a long way to change the alphabet of recovery from “K” to “V”.

Indian economy is on the verge of the worst economic collapse since the lockdown was announced in late March. More than 75 lakh Indians have caught infection with hundreds of them dying every day. On economic front, GDP numbers are contracting, business activity and corporate profits has been severely squeezed with private consumption and investment still in doldrums. Yet stocks market remains bullish and keeps on climbing up. It seems as equity market is clearly disconnected from the real economy.

It was in the month of March when Indian stock market plunged and touched new lows owing to sudden and unexpected announcement of lockdown. On March 23, BSE Sensex hit a record low of 25,981 while Nifty touched another low of 7,610 points. However, stock market indices started recovering within a month with BSE started trading above 30000 and Nifty above 9000 in April.  Indeed, in the recent time, both Sensex and Nifty have regained their positions back with BSE hovering above 40000 and NIFTY above 11500 in the second week of October.

In spite of equity market bouncing back to its original levels in a very short time and such trading highs recorded in recent month, the economy has remained much weak in the last two quarters.  The latest released data showed that India’s GDP dropped by 24% in the April-June quarter of 2020-21 with core sector data and factory output shrinking in the past few months. Even other economic indicators such as manufacturing and services PMI (purchasing managers' index) recorded a reading of below 50 for couple of months, indicating contraction in business activity. Going forward also, various rating agencies such as ICRA and CRISIL have predicted a GDP contraction of 12% for the second quarter (July-September quarter) with RBI predicting a negative growth of 9.5% for the whole fiscal year of 2020-21. The above numbers clearly indicate that stock market is not representative of the entire economy.

Economists give different arguments to support this dichotomy between stock market and economy. Most economists view that stock market investment is driven by greed, fear and is much about future expectations and speculations. The inflow and outflow of foreign portfolio investments (FPI) makes stocks market more sensitive to global developments; thus detaching it from the domestic economic environment. Another reason for this disconnect is the composition of the stocks market, i.e. the giant companies listed on the stock exchange operate under very different circumstances than small businesses and informal workers that represent the major section of the economy. These big firms are highly profitable, hold significant sums of cash and have regular access to public bond markets; hence are more likely to survive any cyclical downturn with minimal impact on their share prices. Further, as these big companies are forward looking and are far more global in their approach, their stock prices tend to incorporate economic recovery expectations in much advance in their share price valuation and movements. To exemplify, the top companies listed on NSE and BSE such as Reliance, TCS, HDFC bank, Infosys, Bharti Airtel were least impacted from the pandemic induced downturn. Moreover, Mukesh Ambani’s Reliance have continued to climb this year with Jio cracking new deals with Facebook and others to add more than $10 billion dollar under lockdown phase. On the global front too, IT and retail giants such as Amazon, Google, Facebook and Apple have performed exceptionally well in the last six months.

On the other hand, the common man has truly borne the brunt of lockdown. Thousands of people have lost their jobs with millions facing salary cuts. Small businesses have shut down and daily wage earners continuing to work hard for two meals a day. Furthermore, a large chunk of others such as restaurants, hotels, real estate, airlines, and tourism, are struggling to cover even costs. These examples reiterate the fact that on one side, most IT, software and e-commerce companies reached all-time highs, while lower income, blue collar workers, small businesses and those that cannot work remotely suffered the most.

Since the lockdown began, the economists were divided on the issue of the shape that the recovery may take, i.e. an optimistic "V" shape or a pessimistic "U" shape or rather a “Nike swoosh” shape depicting a steady and gradual revival after slump, with many of them batting for Air Jordan recovery. However, contrary to expectations of a Nike swoosh, economy is heading towards a K-shaped recovery with wealthy section of the economy quickly bouncing back to pre-pandemic prosperity while lower strata of economy continuing to be in dire straits. A shift in the growth trends can be clearly observed where recovery is leaving those behind with less access to the technology; indicating that inequality within the society is growing larger.

However, government’s effort towards removing the falling part of the “K” through well-directed stimulus package to uplift demand in declining sectors can go a long way to change the alphabet of recovery from “K” to “V” and reduce the gap between “haves” and "have-nots". Conversely, the COVID relief packages announced by government since April have been largely inadequate with limited capacity to support a holistic, inclusive and faster recovery. Considerable part of financial stimulus has been in the form of indirect support such as reduction in lending rates, credit guarantees and liquidity injection measures and thus has proved to be ineffective in generating higher demand and credit growth in affected sectors.

It has to be understood that it is not the cost of money or liquidity shortage but a collapse in demand caused by prolonged economic uncertainty caused by corona conundrum that has held investment and private spending back. Therefore, what’s the use of massive liquidity infusion when there is no demand for credit from businesses and consumers? Instead focus should be shifted on raising demand either through direct cash transfers or distributing some monthly spending vouchers in hands of lower strata of population in order to raise their spending capacity. In addition accelerating all the planned investment would also help in raising demand and creating new employment opportunities.

Although above mentioned demand boosting measures would mean a higher fiscal deficit for government; but at this moment, the need of the hour is a robust fiscal stimulus package by the government to spur domestic demand and investment without being much worried about the fiscal slippages. To this end, the option of one time “debt monetisation” can be considered by Centre in these unprecedented times.

Another large section of society adversely impacted by COVID is informal workers and self-employed in MSMEs. To this end, fiscal measures such as tax reductions, refunds, clearance of dues, bailout from paying utility bills, reduction in property taxes and fees, Interest subvention and provision of wage subsidies can help them to sail through these difficult times.

One more important segment of economy that can’t be ignored is rural migrants employed in urban areas. An unexpected and stringent lockdown announced in March resulted in millions of informal workers employed in urban areas losing their jobs and migrating to their native villages.

In this regard, to support livelihoods of returnee migrants, revamping of Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS) with greater outreach and fund allocation can play a vital role in reducing their woes. Present provision of guaranteed 100 days of employment under the scheme is too less to provide enough employment avenues for returnee migrants in this extraordinary time. There is already a provision to extend the number of guaranteed days of work under the scheme from 100 to 150 at a time of drought or national calamity. Taking into account the growing miseries of migrant’s labour this year; it should be extended to 200 days of work.

Further, under Covid relief package announced in March, the wage rate under MGNREGA has already been increased by 11% from Rs.182 to Rs.202.  However, it still remains below standards. In this light, to make MGNREGA a more sustainable means of livelihood for returnee migrants, government can think of giving MGNREGA wage rate another raise of around 10%. Moreover, for generating large scale employment under the scheme and to spur rural demand, on the spot enrolment on the worksite should be encouraged with wage payment to be done in cash on the same day. Clearing any pending wage arrears as early as possible can also support their falling purchasing power in the near future.

Just like we have MGNREGA for rural employment, India desperately needs a nationwide urban employment scheme for urban poor living in urban areas. To this end, Jean Drèze proposed scheme called DUET (Decentralised Urban Employment and Training) for urban areas can be considered in future.

Lastly, to reduce the growing income inequalities on one hand and to generate additional revenues for covid relief on the other, government can think of reintroducing wealth tax or increasing the surcharge imposed on super rich. In this context, the option of Indian Revenue Service Association’s (IRSA) suggested wealth tax (under “FORCE” report) on the “super-rich” with net wealth greater than Rs 5 crore and a one-time COVID relief cess of 4% can be explored.

Going forward, Centre’s well directed stimulus and income redistribution measures from the rich to the poor would go a long way to change the shape of alphabet of recovery from “K” to ”V” and further mitigate the effects of pandemic on lower income group, going ahead.