India cannot afford a stock market crash

A shock would pulse through the economy all the way to the grassroots

Good morning! 

This is the first edition of The Intersection. This is slightly different from our usual programming. Here we write an original story on the intersection of business, technology, economy and culture. Hence, it's called intersection. Oh yes, today’s story will take just five minutes of your time. Just like The Signal. On to the story.


An investment of Rs 100 in the National Stock Exchange’s benchmark index Nifty would have grown to over Rs 150 in the past one year. That is a return of more than 50%. In FY21, it had returned over 70%. Not bad for a period through most of which the Indian economy was barely going at half throttle.

The remarkable rally in stock markets during the pandemic has puffed up the wealth of many Indians. The richest, Reliance Industries chairman Mukesh Ambani, is now worth more than $100 billion. It has also lifted some smaller boats. That is both reassuring and worrying. It is reassuring because it means India is awash with capital which could potentially flow into new projects that will fuel sustained growth. It’s worrisome because a shock would erode the wealth of not only the rich, but also destroy the earnings of millions who have newly entered the market. It will trigger a ripple that will surge through smaller cities and towns where jobs are scarce, affecting discretionary spending and deepening the income crisis.

The high

The current ebullience, despite the pandemic, is unsurprising. Big firms squeezed suppliers, customers and workers to preserve risk capital. The share of corporate profits in India’s GDP rose to a 10-year record of 2.63% last year from just 1.6% in the previous year. The combined profit of listed companies grew more than 57% over the previous years’ level. One estimate suggests that in less than two years, just 360 top companies’ net profit will rise to about 5% of GDP. As the head of equity research at a foreign broking firm, who did not want to be named, told The Intersection: “The law of the jungle played out.”

The show drew more and more money to equities. Three streams fueled the rally. The first is global liquidity. India has been one of the hottest destinations for foreign portfolio investors who poured in over $37 billion in FY21, more than the previous six years combined. They brought in another $7.8 billion this year. Second, equity mutual funds saw steady inflows until August, the first month they slowed. The third is the new retail investor who has channeled savings to stocks seeking better returns than the measly earnings from bank deposits.

The launch of Reliance Jio in 2016 set off a cheap-broadband revolution, helping fast internet and fintech to penetrate small towns and villages. Proliferation of gamified trading apps netted a new class of young and risk-savvy retail investors. Depository CDSL reported that it added 10 million dematerialized accounts in five months. Individual stock holding accounts swelled overall to 65 million. The new accounts were mostly opened from small cities and towns. Investors scrambled to download online broking apps such as Zerodha, Paytm Money and Upstox. Over 75% of Zerodha’s clients trade from their mobile phones.

The low

The market exuberance hides widespread pain in the broader economy, especially at the level of households and small businesses. RBI data reveals that loans against gold jewellery—the trusted rainy day stash of most Indians and hence a good indicator of economic stress—rose 81% in FY21. Worse, many who pledged gold seem to be unable to redeem it. Shadow bank Manappuram Finance auctioned pledged gold worth Rs 8 crore in the first three quarters of FY21, but worth Rs 404 crore in the last quarter alone. That number tripled to Rs 1,500 crore in the first quarter of FY22. Manappuram only has a sliver of the Rs 2 lakh crore organized gold loan market which itself is only about a quarter of the total. The rest is in the unmeasurable informal sector.

The earlier quoted head of equity research quipped: “In deeply unequal societies, the pain will be borne by the bottom and the knowledge and capital will be preserved by the top.”

Three years ago, economist Rathin Roy wrote that the Indian economy is geared to the needs of about 100 million consumers. There is a reason why the Sensex does not include stocks of companies that sell basic clothing, affordable healthcare or education. The leading indicators used for growth forecasting in India—aviation, automobiles, FMCG, and housing—are the lodestars of that 100 million consumer world, Roy argued. This group is the cynosure of companies that rule the roost on the stock market and new-age businesses as well. Credit card payment company, CRED, for instance, targets those with good credit scores.

Credit scorer Transunion CIBIL has estimated that only about 200 million out of India’s working population of 400 million are credit active, meaning they have borrowed a formal loan or own a credit card. The other 200 million do not have the wherewithal to repay and hence can’t get bank loans. The pandemic has blown a hole in the sails of India’s capital-starved small and micro industry, where most of these workers find employment. Central bank data shows credit growth to these companies shrank 6.4% last year and by 3.5% so far this year.

Businesses that can scale quickly have no dearth of money because they can tap into domestic and foreign pools of angel investors, venture capitalists and private equity. In 2019, Reliance repaid about Rs 1.6 lakh crore debt by selling equity in Jio Platforms to 13 investors, including Google, Facebook and Intel Capital. Large companies repay loans and banks lose out potential interest income from low-risk clients.

The squeeze

Equity or cheap debt is available to large companies, but the small ones that almost entirely rely on credit have an uphill task. India does not have a vibrant corporate bond market. Few get easy credit from banks. Many tiny ones now borrow on peer-to-peer (P2P) lending platforms where lenders and borrowers meet directly. One P2P lender’s dashboard showed the average interest rate at 24.37% on September 9. Demand stood at Rs 252 crore while supply was only Rs 165 crore on that day.

The fortunes of small companies, many of which are suppliers to bigger firms, depend on discretionary demand picking up and translating to orders trickling down the chain, eventually boosting employment and incomes. Even there, bigger brands are eating into the market of small players. In Tamil Nadu, rural sales of branded electrical fittings are rising as unavailability of polycarbonate (the raw material) put several local makers out of business, a home fittings dealer in Trichy told The Intersection. He said bigger brands are also introducing cut-price products to compete with local makes. Such shifts create hyper-local economic changes that are near impossible to quantify.

Banks end up losing low-risk big businesses as well as high-return small ones that add up the volumes. Small firm bankruptcy also hits bank branches which act as funnels adding borrowers and mobilizing deposits. Combined bank deposits have grown only 3% this year.

Investment does not depend on cold numbers alone. Sentiment and environment play a large part in the final decision. The stock market is the biggest indicator of sentiment and a big crash which usually follows steep run-ups would deal a shock to economic recovery. The trigger could be external. The US Fed Reserve tapering its bond purchases, for instance. At the moment the Indian economy is on the edge and the stock markets and retail investors may have an oversized role to play in its future direction.

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