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Equity markets and the economic slowdown

Ashwini Arulrajhan

Almost a year has gone by since the equity markets corrected steeply in September 2018. It was the first steep fall after an incessant bull run which lasted around 3 years. And it wasn’t just a knee-jerk sell off. IL&FS, an infrastructure finance company, defaulted on several of its debt obligations sparking a system wide liquidity crunch. Some even compared it to the collapse of Lehmen Brothers in 2008. Sensex fell 14% in a little over one month. Of course, it was nothing close to the 55% fall it experienced in 2008. But for the domestic markets, the implications were huge. With credit in the system drying up, several other companies like Zee group, Reliance group and DHFL defaulted on their payments.

Short-lived euphoria

As the plague was slowly spreading, markets decided to focus on other things. Classical economics assumes individuals to be rational. But there is enough and more study on irrational human behaviour. We have plentiful examples in the equity markets. This is one of them.  Stakeholders are continuously betting on diverse outcomes based on their expectations. While a lot of factors that affect companies’ profitability go into forming these expectations, there are some uncertain events which may derail the projections. And what the markets tend to do, is give these events undue importance. In our case, this event was the grand general elections in May 2019.

From a business perspective, NDA winning meant continuity in policies and better implementation of reforms. And that’s what the investor community was hoping for. The market was building in a rally well ahead in October 2018 which was further  fuelled by the exit polls. At the same time, skepticism was also building up. Analysts would explain, how the elections have little impact on the companies’ performance in the long run. Under different governments, businesses have continued their operations by adapting to different political and investment climate. And that meant, the real focus should be on which businesses would fare well despite the odds. This focus came only after the election results, with NDA bagging a yet another big mandate.

Back to fundamentals

The celebrations were over much before the big win. From the bottom in September 2018, Sensex rose about 19% by the end of May 2019. Much of the risks that were prevalent back then still persists. Globally, concerns about trade wars and protectionist policies linger while domestically, liquidity conditions haven’t improved.

There are a number of metrics that are signalling a slow-down in the economy. India’s GDP growth narrowed to 6.8% for FY19 from 7.2% in the previous fiscal, sliding to the lowest growth rate in 5 years. However, this is not isolated to India. Important economies like US and China have also been experiencing slowdown which is affecting the demand in emerging markets. Furthermore, global factors haven’t been conducive. Lack of progress in US and China trade talks is weighing on the sentiments while there is a fresh spark of retaliatory tariffs on US goods by India after being removed from the preferential trade agreement.

Amidst this uncertainty, exports declined sharply by 9.7% in June’19 compared to an increase of 3.9% in May’19. On the positive side, oil prices supported the trade deficit as imports fell by 9.1% in June’19.However, non-oil, non-gold imports also fell steeply by 9% revealing lacklustre demand.

On the domestic front, Industrial Index of Production (IIP) which measures performance of sectors such as mining, electricity and manufacturing, also crept downwards. Key trade growth indicators such as cargo and container traffic at major ports were also on a decline as a result of sluggish industrial activity. The prolonged slump in automobile demand saw no respite as retail demand remained weak and inventories were high.

With the slow down weighing on the markets, Sensex has been moving down in the last 3 months. Shaktikanta Das, the RBI governor, asked the investor community to stop sulking because ‘mood of gloom and doom won’t help anyone’. But market euphoria without addressing the structural concerns will only result in a bubble.

The finance minister, last week announced a slew of measures to address these concerns. From steps to increase to auto demand to rollback of surcharge on the super-rich, the measures tried to address different concerns. With monsoons not lending support, the economy is looking for a push from government spending as well as revival in consumption demand. To improve liquidity, the government also provided a one-time corporate guarantee to banks to encourage them to lend to NBFCs. Additional inflows for recapitalisation of banks may enable them to extend more credit. Now, the markets are keenly watching out for distinct signals for revival.

Ashwini Arulrajhan is an economics graduate from Symbiosis School of Economics. She is currently working in the finance domain.

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