Last Updated on Jul 11, 2024 by Harshit Singh
Welcome to the July 2024 edition of Netra, where we present data-driven market insights that can inform your investing decisions.
This month, we’ll talk about a common market myth, what’s on the cards for government spending in India, and how the state of household savings might impact a key macroeconomic cycle.
Table of Contents
Equities and the economy don’t always get along
It’s a widespread belief among market participants that economic growth is coupled quite strongly with equity returns: better growth equals higher returns, and vice versa. However, data indicates that this idea is overly simplistic and hence flawed.
Case in point: Brazil, which has delivered the highest real returns for investors over the past 30 years, has seen its economy grow only moderately over that time. And on the flip side, China, with its explosive GDP growth, has yielded negative real returns.
Source: Bloomberg, CMIE, DSP; Data as of June 2024.
Why? Well, stock returns depend on earnings growth. To deliver long-term gains that beat those of bonds, companies have to consistently create value for shareholders. This happens more rarely than most people think: in every country and company, there are always events outside of anyone’s control that have the potential to derail or stop growth.
What this means for you: don’t use the economy as a proxy for the equities market. Instead, keep your eyes squarely on company earnings and the corresponding stock prices.
Procyclical headwinds incoming?
Since the start of this century, India has faced two major economic shocks: the 2008 Global Financial Crisis (GFC) caused GDP growth to drop from 8% to 5.5%, while the 2020 Covid-induced recession led to a 6.1% contraction in FY21. Both events triggered significant countercyclical stimuli from the Indian government and RBI.
In the wake of the GFC, government expenditure for stimuli remained high for a relatively long time. This eventually led to a double-barreled balance sheet problem when a flare-up in oil prices negatively impacted India’s balance of payments. Another issue India faced during this period was its inability to run a large fiscal deficit, because the US and India’s other trade partners were also being more circumspect and fiscally tight at the time.
However, from FY25 onwards, the gliding path of fiscal spending could turn procyclical. This means government spending may slow down in tandem with the end of the economy’s post-pandemic growth spurt. The central government’s revenue expenditure growth has slowed, and capital expenditure growth is also tapering. And this gradual reduction in government expenditure growth could be a drag on the GDP for the next few years.
As the graph below indicates, the real GDP growth and gross fiscal deficit are both likely to be trending downwards in FY25.
Source: Govt Docs, CMIE, DSP; Data as of June 2024.
Private capex losing out on household savings
Indian households’ savings are getting increasingly de-financialised: household net financial savings (HHNFS) collapsed to a 47-year low of 5.3% of GDP in FY23.
Source: Nikhil Gupta, Motilal Oswal Research, DSP; Data as of June 2024.
There are two main reasons for this: the first is that consumption growth is outpacing income growth, while the second is that households are leaning heavily into physical assets (primarily residential real estate) rather than financial assets.
Household physical savings hit a decadal high of 13.2% of GDP in FY23, and accounted for more than 70% of total household savings. It is likely that the HHNFS has picked up slightly in FY24, but total household savings remain low.
At the same time, household debt has risen sharply during the past two years, and is estimated to have risen to an all-time high of ~37% of GDP in the first half of FY24, beating the previous high of 36% in FY21. More importantly, the share of non-housing personal loans (i.e. consumption loans) has risen the most during the past few years.
Source: Nikhil Gupta, Motilal Oswal Research, DSP; Data as of June 2024.
What are the implications of these developments? If wage and salary growth remains poor relative to real rate growth, then debt-fueled household revivals could be derailed, eventually leading to reduced consumption. In addition, given that the financialisation of household savings can fund private capex, the latter could be hurt by their de-financialisation. Thus, these developments are key risks when it comes to the longevity of the current capex cycle.
The bottom line
It seems obvious that economic growth and equity market growth should go hand-in-hand, but the data indicate that there isn’t a neat correlation between the two, as there are always many uncontrollable factors at play. In addition, with India’s post-Covid growth slowing down, the Indian government might also spend less from FY25 onwards, potentially putting some downward pressure on the GDP. Lastly, Indian households are putting less of their savings in financial assets, and are taking on more consumption-oriented debt, creating a situation where the current capex cycle might come to an end earlier than it might otherwise have.
For more actionable insights backed by data and analyses, we invite you to read the latest edition of Netra in its entirety.
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