India growth forecast was cut to 7% for 2019 and 7.2% for 2020 by the International Monetary Fund in the latest update of the World Economic Outlook. This is a downward revision of 0.3% for both the years.
Let us take a look at four economic indicators mentioned by the IMF to have caused this slowdown in India’s economy and how they affect corporate growth and the stock markets.
Consumer spending or consumption refers to the goods and services bought by households to fulfil daily needs. The items that are bought by consumers create the demand which pushes companies to manufacture more of what the consumers are buying. This drives their sales and helps them expand their businesses and derive profits. When companies perform well, their stock prices go up and investors who have invested money in stocks of such companies stand to make profits. It also has a positive impact on stock market trends. The IMF quoted ‘weakness in consumption’ as a reason for the downward revision of India’s GDP growth rate. Rural consumption, which accounts for about a third of the market. has also slumped in India in the last three quarters. Decreased sales of branded daily needs have had a corresponding effect on manufacturing, thus making it difficult for companies to expand their businesses.
Demand, in simple terms, reflects consumers’ ability and desire to purchase goods and services. Demand motivates businesses to produce more and is the underlying factor behind economic growth and expansion. Demand is dependent on personal income and wealth and its main component is consumer goods and services. Domestic demand is overall demand for all goods and services in an economy. The five components of domestic demand include consumer spending, investments by businesses such as purchase of equipment etc, government spending on goods and services and exports. When domestic demand falls, consumers buy less and there is less incentive for companies to manufacture goods and services. Drop in sales pulls down profits which in turn pushes away investors and stock prices fall. According to the IMF, “There was weaker than expected domestic demand,” which led to the downward revision in the growth forecast.
When the production of goods and services increases in an economy, it leads to economic growth. An important factor that governs the increase in production is the level of investments made by businesses.
Investment refers to the sum of money that is accessible to a company for fulfilling its business objectives. It means purchases on capital goods which are assets such as factories, machinery, equipment, etc. These improve the productivity of a company allowing it to produce more goods and services while making the process cost effective. As a result, profits and revenues of businesses rise which stimulates corporate growth and has a positive impact on the stock market. Lack of investments also affects jobs which reduces consumer spending and that too affects corporate profits.
The IMF report quoted a “weakness that was fairly broad-base in investment” and attributed to the uncertainty prevailing among investors due to the elections. Thus, weakening investments means lower profits for companies and poor performances of stocks.
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When interest rates are low, companies actively borrow from banks and financial institutions for expansion. They hire more people, promote research and development and ultimately all this leads to an increase in the production of goods and services and improvement in quality. This also means that the repayment ability of corporate borrowers becomes stable. However, when credit availability is tapered in an economy, companies find it difficult to expand and sustain profits. In this situation, corporate growth becomes stunted, stock prices fall as investors do not show keenness in investing in companies where the growth prospects are low. The stock market can thus take a hit during cycles of low credit availability.
According to the IMF report, “tightening of financial conditions, especially for borrowing by small and medium enterprises” has also caused economic slowdown. In India micro, small and medium enterprises (MSMEs) face issues in terms of credit availability and 40 percent of lending to MSMEs is through informal channels, as stated in the 208 report titled, ‘Credit disrupted: Digital MSME lending in India’.
The NIFTY India consumption index slipped 5.7 percent as on July 23. This index reflects the performance of a diversified portfolio of companies representing the domestic consumption sector including consumer non-durables, healthcare, auto, telecom services, pharmaceuticals, hotels, media & entertainment, etc. This can be seen as a sign of the falling consumption and demand in the economy which have affected the stock prices of the companies listed in this index.
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