Neelkanth Mishra cautions against reading too much about the Indian economy from the stock market gyrations. I agree completely.
He also argues that stock markets react to global economic weakness, in particular, problems in emerging markets (EM), the category to which India gets bundled,
The market capitalisation of the top 100 stocks (BSE100) has fallen by 5 per cent in the last 12 months, whereas for the next 400 stocks (let’s call them the Next400), the aggregate market capitalisation has increased by 9 per cent... The larger stocks are more pressured by FII selling as they have higher FII ownership, and they also have much higher fundamental linkages to global trends. The Next400 stocks are dominated by sectors like consumer discretionary and non-banking finance companies that are less exposed to global trends, and better reflect the improvement in the Indian economy. They are also less owned by FIIs...
Indices regularly shed weaker companies and add stronger ones: Over the next few years, as the Indian economy continues to outperform global trends, it is likely that they may become more representative of the economy. Similarly, it is likely that India becomes an “asset class” by itself, that is, given its idiosyncratic economy, global savings may choose India-focused funds rather than investing in India through EM or Asia funds.
This conclusion is baffling and as misleading as the Sensex is of the economy. For a start, the share of the Next 400 in the total market capitalization is most likely to be disproportionately small. More importantly, the hope of India decoupling from the EM asset class and acquiring its distinct identity among international asset managers and other financial institutions goes against a voluminous body of research on cross-border capital flows which clearly indicates that it does not discriminate based on fundamentals. It may, therefore, be unrealistic to assume that India can, based on a few years of growth, emerge as an asset class distinct from the broader EM category.
At a more broader level, such reasoning presumes that it is possible to have a significant share of the domestic economy, one that drives economic growth, largely insulated from the rest of the world. This overlooks the fundamental economy-wide structural imbalances and limitations, arising from the very narrow corporate and industrial bases, in a landscape dominated by small and informal enterprises. It would require more than economic growth to address these problems.