India's Markets Could Well Recover. But Not Because of What You Think

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India’s stock markets have been falling steadily for more than a month. The benchmark Nifty 50 index is down 8 percent. Reliance Industries, our most valuable company, has dropped nearly 20 percent from its all time high.

Despite the fall Nifty has gone up almost 25 percent in one year. The same money kept in a fixed deposit would have earned one-third of that amount. So, long-term investors have a long way to go before they start losing money.

The problem is for those who came late to the party. And those who make a living out of short-term trading on the markets.

On the face of it, even that is not a big deal. If you invested Rs 1 lakh in late September, in a portfolio of stocks that mimics the Nifty, you would be down just Rs 8,000 right now. That’s worrying but not enough to stop you from sleeping at night.

But what if you had borrowed money and invested that as well? This is exactly what traders do – they leverage many times over to bet on the markets. This results in big gains when the markets are booming, but also to huge losses when the markets fall.

For example, suppose you had Rs 1 lakh in your bank that you wanted to bet on some quick gains in the market. If the shares you bought went up by 20 percent in one month, you would have made Rs 20,000. This is great, but not enough for you to give up your job and become a full-time trader. For that, you need much more capital.

So, now you borrow Rs 4 lakh from the bank and invest it along with your own Rs 1 lakh in the markets. If your shares gain at the same rate as earlier, the Rs 5 lakh you invested would become Rs 6 lakh. If you borrowed at an annualised rate of 12 percent, you would have paid Rs 4,000 in interest in one month. Even after returning the money you borrowed, with interest, you would be left with a gain of Rs 96,000. That’s a 96 percent return on your original Rs 1 lakh.

But what if the markets fall 20 percent?

If you invested only Rs 1 lakh, you would lose Rs 20,000. But if you borrowed and invested Rs 5 lakh, it will become Rs 4 lakh, all of which will have to be returned to the bank. That’s not all. You would have not only lost the entire Rs 1 lakh of your own money but would have to pay the bank an additional Rs 4,000 in interest. That’s a 104 percent loss.

No wonder, even a small ‘correction’ in the markets can wreak havoc among active market players.

This explains the current noise about the stock markets, but it doesn’t tell us why they are falling. To understand that we will have to take a closer look at the actual businesses behind share prices.

There is one thing that almost all stock market gurus agree on. Share prices might fluctuate depending on sentiment and the availability of money in the economy, but in the long run they track corporate profits.

Take the BSE 100 index, which represents a basket of hundred most valuable and traded companies in India. It gave an annualised return of about 15 percent in the five years between 1 April 2019 and 31 march 2024. The total profit after tax of these 100 companies grew at an annual rate of 16 percent, virtually mirroring the returns on the stock markets.

How does this compare with India’s economic growth in the same period? To compare that we have to look at the growth in our nominal GDP, unadjusted for inflation. That is because both stock market returns and profits are reported at current prices.

Nominal GDP grew at just 8 percent, or half the rate at which profits grew at the top 100 companies. In fact, their sales growth perfectly tracked the growth in nominal GDP, also growing at 8 percent per year.

What do these figures tell us?

The obvious conclusion is that the corporate sector’s share in national income has risen at the expense of others. If we look at just the BSE 100 companies, their share of nominal GDP is up from 1.9% in 2018-19 to 2.7% in 2023-24. Expand that to the CMIE’s universe of roughly 5,300 companies, then their share of nominal GDP has risen from 1.7% to 4.4%.

Note that in 2018-19, the top 100 companies made more aggregate profits than the entire listed corporate sector. That means there were many loss-making companies in that year, and a much larger number had transitioned to becoming profitable five years later.

This remarkable growth in corporate profits has largely been driven by two things: lower taxes since mid-2019, when corporate taxes were cut, and a sharp drop in interest rates during the COVID lockdown between 2020 and 2022.   

On the other side, the salary bill of the corporate sector has seen a much more modest rise, from 3.3% of GDP in 2018-19 to 3.8% in 2023-24. Anecdotally, we know that median white-collar salaries have been more or less stagnant for almost a decade. So, even this rise in the salary bill would have been driven by big hikes for top managers, especially the C-Suite employees.

The result of this can be seen in India’s consumption pattern. As India’s middle-class has started to shrink, the sale of mass consumption goods has not kept pace with economic growth. The sale of premium products and services, on the other hand, has exploded.

There is a limit beyond which the rich cannot compensate for the slowdown in consumption among the middle class. We have now reached a saturation point. This is clear from the government’s national income data – while our GDP grew by more than 8 percent last year, household consumption rose by just 4 percent.

No wonder many consumer-facing companies have started expressing their worries about shrinking demand for what they sell. The markets are reacting to such commentary, because investors adjust their bets based on what they think companies will earn in the future. Brokerages have also played a role in dampening expectations; they have downgraded earnings estimates of two-thirds of India’s large listed companies.

What does this mean for India’s markets?

No one really knows, because share prices are impossible to predict. While the slowdown in demand might continue to affect corporate revenues, their costs might go down at a faster pace, especially if interest rates moderate. Even salary bills might be reduced given that the shortage of white-collar jobs will enable companies to hire people at lower salaries.

That means corporate profits may continue to rise even as sales stagnate, or even fall in real, inflation-adjusted terms. If that happens, the markets will recover, even if the economy doesn’t.

(The author was Senior Managing Editor, NDTV India & NDTV Profit. He tweets @Aunindyo2023. This is an opinion piece. The views expressed above are the author’s own. The Quint neither endorses nor is responsible for them.)