India is on the cusp of a momentous feat. As the nation celebrated the 75th year of its independence, it also recently edged past its former colonial master to become the 5th largest economy in terms of nominal GDP. It took the country 50 years of independence to become a trillion dollar economy, while the next two trillions have come in 7 years each. It is also likely to become the third largest economy by the end of this decade, as per the recent IMF projections.
The objective of this article is to trace this journey of Indian economic growth through the rise in its stock markets and see if there exists any telltale signs of what is in store for India @ 100.
Journey of the Indian Stock Market
Even though India is a part of the emerging market basket, it has well developed and sophisticated financial markets, best depicted by the presence of the oldest stock exchange in Asia, the Bombay Stock Exchange (BSE), established in 1875. The bellwether index, the BSE Sensex has gone up almost 400 times since inception, at a CAGR of over 15%p.a.
The market capitalization of all companies listed on the BSE have gone up significantly from just over Rs. 6lakh crore in 2002 to over 28.3 lakh crores in September 2022, a growth rate of over 20% compounded annually. The BSE Sensex over the similar period has grown at a CAGR of just over 15% from around 3300 in 2002 to almost 60000 in 2022.
The fact that market capitalization of all companies has grown at a significant rate than the annual returns of the Sensex is in part dealt by Jay Ritter (2012) which says and I quote “… that investors realize only on the shares that they hold, not on shares that may later be issued by the same companies to other investors. … Part of an economy’s growth, as we have already seen, can be attributed to savings invested in new companies, and to the issuance of new securities by existing companies. But the gains on this capital investment do not necessarily accrue to today’s shareholders.”
This basically means that as more companies which are yet to be listed find their way to the bourses, the total market capitalization of the country rises, a fact which is not necessarily captures in the returns on the Sensex. There are two further explanations to this. One, not all companies which get listed on the exchange get included in the Sensex 30, as any such inclusion is based on the size of the float and turnover criterion and two, even if a newly listed company does get included, this itself may happen with a lag and thus, the return it has generated in the meantime is not captured.
A big chunk of companies which hit the bourses post the bear market which ended in 2003-04 have gone on to become mega corporations such as TCS & Maruti & DMart while the large PSUs which have only recently been listed include the likes of Coal India & LIC. All such corporations have contributed to the significant outperformance in the rise of market capitalization vis-à-vis the Senex. It is also reflected in a popular market hack/myth that companies underperform the index upon inclusion as most of the prices have run up ahead of their eventual inclusion.
Relationship between Economic Growth & Market Returns
There is a rich literature which has analyzed the role of economic growth in stock market returns. Ritter (2005) has found a negative correlation for the compounded real return on equities and the compounded growth rate of real per capita GDP for 16 countries over 1900-2002 period. Krugman (1994) & Young (1995) have argued that much of real economic growth in emerging markets comes from high savings rate and the more efficient utilization of labour, neither of which necessarily translates into higher profits accruing to the shareholders of existing firms. Dimson et al (2010) too found a negative correlation between real growth in GDP per capita and real equity returns. They also opine that the stock markets anticipate future growth and run up ahead of the curve and thus, high growth countries does not necessarily are the best performing stocks.
In case of India, for the period 2002-2021, we observe a very strong positive correlation of 0.94 between the growths in total market capitalization of BSE listed companies and GDP in absolute terms. On the other hand, a small negative correlation exists in each of growth in market capitalization v/s the returns of Sensex (-0.201) as well as growth in GDP v/s the returns of Sensex (-0.2183). This is in line with the literature which also observed that economic growth in a country is not necessarily translated to higher stock market returns and vice versa.
It can be argued that the Sensex 30 companies contribute just over 40% of the total market capitalization, and thus may not be a true proxy to capture the real returns of the markets. Keeping this in mind, data for BSE 500 index was utilized to observe if the above thesis stands ground. A similar level of negative correlation (-0.26 for BSE 500 v/s growth in GDP while -0.21 for growth in market capitalization to BSE 500) was observed.
An interesting observation, however, was in store while working the same set of data in absolute terms. A highly positive correlation of 0.94/0.96 was observed between the total market capitalization v/s the Sensex 30 & absolute GDP at market price v/s the Sensex. Similar correlation figures of 0.961 was observed for the Sensex absolute value v/s the per capita GDP in dollar terms for the period 1980-2021 and correlation figure of 0.952 for total market capitalization and the per capita GDP for the period 2002-2021.
The above points to a scenario where over the long term, a rising GDP results in a rising Sensex as well as higher total market capitalization even though a growth in GDP may not necessarily mean or indicate a positive return on the index in that particular year. The most obvious examples of this are years 2008 & 2020. In the former, the stock markets nosedived along with its global peers while the Indian GDP managed to hold fort against a wave of global meltdown. On the other hand, in 2020, the Indian GDP recorded its first negative economic growth in over 40 years while the stock markets managed to climb all walls of worry and registered a strong positive year.
Journey of the Domestic Investor-
Even though India has a large tradition of stock market investing, majority of the household savings have habitually been parked in gold and real estate. In the era of socialist policies, it was an ultra-socialist Minister, George Fernandes who inadvertently led to the birth of equity cult in India. As Industry Minister in the then Janta Party government, he forced the MNCs to dilute their stake in their Indian subsidiaries and thanks to the then prevailing policies, global majors such as HUL were forced to list their stocks at controlled prices on the domestic stock exchange. Alongside came Dhirubhai Ambani with the listing of whose Reliance Industries in 1977 and through its subsequent rights issues, then begun the first phase of equity cult in India.
Indians, however, have been slow to take the plunge. The total number of Demat accounts, a proxy of actual investors participating in the markets only numbered around 4 crores until 2019-20. Then Covid struck and Indians who found themselves stuck at home suddenly thronged to the markets in hordes. Thanks to the online onboarding by digital stock brokers, the total number of Demat accounts have jumped significantly to over10 crores in September 2022.
One reason which may be theorized is the rise in discretionary income in the hands of Indian populace. A proxy for this is the per capita GDP of the country, which has grown admirably from a lowly $82 in 1960 to over $2270 in 2021. According to the IMF, it has crossed $2500 in 2022. As the income in hands of people increases, they have more money left to either consume better goods or to invest. According to the World Bank, India’s household savings to the GDP stands at 29.3% in 2021. This translates to roughly $900 Billion of savings. A major chunk of this savings is parked in non-financial assets such as real estate and gold, etc. A trend, however, is slowly emerging towards greater financialisation of this savings. A proxy for small investor money flowing into the market is monthly SIP book which stands at record 12693 crores in August 2022.
Road to India@100
India has seen massive growth in its economy and the stock markets over the previous 75 years. The next 25 years, however, are likely to be even better for the nation and investors betting on it. In absolute terms, India is likely to add over a Trillion Dollars in its economy in even lesser number of years as it did the previous years, simply by the law of compounding. This will translate into real wealth for the nation as even at current 29% of household savings rate, the absolute value of such savings is likely to grow into trillions of dollars per annum and that means more resources for everything- infrastructure, welfare and wealth creation.
As the trend of financialisation of savings picks up, the amount of money flowing to the markets will be massive and that is likely to feed the stock markets in years to come. As we have observed, the rise in stock market capitalization moves in tandem with the GDP, Indian stock market capitalization is also likely to scale unfathomable peaks. Even though growth in economy is not necessarily a predictor of stock market returns, in absolute terms, over a long term, stock indices have been known to rise up alongside the economy.
Since the mood is cheerily festive, this is the year of dreaming big and making bold predictions about the future. So here is my two cents. The law of compounding is the eighth wonder of the world, said Einstein (though nobody can be sure about it). Indian GDP growth rate, the new normal of which is assumed to be somewhere between 4-8%, depending on how optimistic one is. The GDP is projected to reach anywhere between $8.8 Trillion to over $23 Trillion, as the chart below depicts. The per capita GDP may also reach anywhere between $6300 to over $16000 in the same time frame.
The most eye catching prediction is what lies ahead for the stock market. Indian stocks have delivered over 15% CAGR since 1980 and as Jeremy Seigel in his famous book, Stocks for the Long Run has depicted, stocks are known to deliver returns above the risk free returns of the treasury over long periods of time. This excess return is what is known as Equity Risk Premium. In India, G-Secs yields have moved between 5-12% for the period March 1998-September 2022. Assuming 3-4% risk premium, let’s see what the Sensex can look like in years to come:
Bet Big on India- it works!
*****
Life is all about Compounding! 