Rally succeeds Reforms
How improved systems, improved processes, improved behavior lead to the growth of the nation, growth of the economy, growth in economic indicators?
It takes time to succeed because success is merely the natural reward of taking time to do anything well. Words of Wisdom by Joseph Ross.
The aforesaid holds true for life, for relationships, for creating wealth, and even for stock markets, which presumably read the pulse, the health, and the wellbeing of the country.
Stock markets, a popular predictive platform, for crystal gazing, foretelling what lies ahead in the underneath real economy, acts as the barometer of the economy, describing and anticipating the general mood of the country’s inhabitants, as well as outsiders.
Ultimately, no one put their bucks on a sinking ship, until it’s a hard bargain.
Thus, stock exchanges are not only the platform to match the buyers and sellers bid and ask of listed securities, but also indicate the state of the elementary grass-root level economy, financial condition, and the underneath concurrent changes which are occurring in the economy in a dynamic manner. Stock markets also reflect the health and state of the business environment.
The underlying belief is when economic stagnation occurs or business activities slows down due to depression in the markets, prices fall. On the contrary, when the business environment is conducive, the real GDP growth rate is buoyant, stock markets replicate that by rewarding investors with rising pricing of securities listed therein. Security prices change with the change in economic, social, and political conditions apart from (obviously) growth in the revenues and earnings (profit after tax) of the underlying business.
Then, there are zillions of factors that also impact the rise and fall of listed stock prices on the exchange. One of them being lower real interest rates. Lower interest rates mean, lower borrowing rates for organizations which mean higher retail or consumption demand using borrowed funds, resulting in higher profits for businesses and firms.
Another variable impacting the spirited stock market is lower inflation. Lower levels of inflation mean benign interest rates to extend for longer periods resulting in buoyancy to float longer, on the other hand, higher inflation kills or reduces the value of money which may mean or indicate a forthcoming regime of rising interest costs.
One more illustrative variable is a stable government which denotes stability in policies, and one which then attracts capital flows, thereby generating employment, and positively impacting the overall Gross Domestic Product (GDP) of the nation. There are several other variables that people follow and track.
However, despite advancement and progress in data collection, one of the most important factors which remain largely ignored by market participants is Reforms. Reforms in the underlying economy enable increased efficiency, increased productivity, and increased marginal output — utilizing the resources available therein.
One of the reasons why reforms remain rather unnoticed or under-noticed is the fact that they come with a lag impact.
There are four lags that create a sense of irrelevancy for an important act known as reforms:
Recognition Lag, which simply means the time taken to collect the compulsive data which will justify such an act of reform. In simpler terms, it’s called Awareness. Fortunately or unfortunately, what impacts the economy, stock markets, investments, also impacts human life. Human life also faces similar kinds of lags, which the ‘reform recognition process’ encounters.
One must remember that reforms are never easy as they involve, change…Change in mindset, change in systems, and change in the process. As soon as change comes into play, Status quo bias (a cognitive bias that says inaction is better than action) takes charge, creating a strong resistance in favor of continuity with existing conditions.
Decision Lag. What quantum, what kind of reforms are needed, whether directed towards short-term or long-lasting ones?
Implementation Lag or in simpler words, the time taken for each of the reforms to be materialized or application of such reforms. Post-implementation repercussions and corrective measures to ensure minimum disruption and maximum effectiveness of such reforms also form part of the Implementation Lag.
Effectiveness Lag, which requires implemented reforms or changes to be assessed, quantified and readjusted, and smoothened. If required, modified, altered as well.
India over the last 74 years, since independence, has gone through such metamorphosis. Though initial few decades, resources were largely spent on building and erecting the crumbling community which was left by Britishers. Post that, the Indo-China conflict and three Indo-Pak wars sucked out a large part of the energy, focus, and resources. Out of necessity, or for survival, or for the indispensability of the moment, India undertook mammoth reforms in 1991.
Some of the biggest reforms which happened between 1991 to 2000 include:
1. Focus and expansion of services as a sector which today contributes ~54% of India’s GDP, from 39% in 1991.
2. Reduction in fertilizer subsidy, getting farm and farmers be independent.
3. Divestment of Government’s equity from Public Sector Undertakings (PSUs).
4. Indian economy was re-opened for foreign capital flows — both in terms of Foreign Direct Investment (FDI) for setting businesses in India, and Foreign Institutional Investment (FII) for Indian stock exchanges.
5. From 1993, the Rupee was allowed to be determined by market forces, thus implementing a market-determined exchange rate.
6. Abolition of import licensing controls for capital goods, raw materials, and intermediates.
7. Reduction in external commercial borrowing norms, especially in short term.
8. Reduction in Statutory Liquidity Ratio (SLR), freeing up banks’ money to be used for lending.
9. Tax reforms and a massive reduction in the country’s fiscal deficit.
10. Establishment of National Stock Exchange (NSE) and legislative empowerment of the Securities and Exchange Board of India (SEBI), the capital markets regulator.
Reforms surely and certainly happened in the next decade as well, from 2001 to 2010, but the pace of reforms was rather slow. One of the major reforms which were implemented in 2005 includes the Right to Information Act, 2005 (RTI Act), which brought greater transparency and accountability in public dealings of public offices in India.
The last decade of the 21st century again saw some far-reaching, forward-looking, efficacious reforms which are capable of taking India to pole position amongst the world's largest economies in terms of growth.
Some of the many reforms which were effectively carried out in the last decade from 2011–2020 include:
1. Demonetization, mass universal banking for nearly every Indian, digitization of the economy and various government departments
2. Direct benefit transfer of all kinds of social payments and subsidies.
3. GST Implementation across India — one nation, one tax regime.
4. Insolvency and Bankruptcy Code (IBC) of 2016, reforms in medical education, corporate tax cuts, and FDI liberalization.
5. Agriculture reforms ending the monopoly of traders and freeing up farmers from restrictions on the sale of their agriculture produce.
6. Implementation of the Black Money bill to deal with illicit money stashed abroad.
7. Liberalization of FDI rules throwing open food retail, airlines, private security firms, and defense companies for higher overseas investment.
The table below shows that GDP growth and stock market growth both come with a lag impact. Decades of 1991–2000 and 2011–2020 saw colossal changes, and results can be seen a decade later.
The decadal average real GDP growth rate for India
*India’s real GDP for FY 20 -21 declined by 7.97% due to COVID pulling the decadal average down. Source: CSO
Sensex returns over 10 years
- Dividends are not included in the returns.
- * CAGR stands for Compounded Annual Growth Rate
- Source: bseindia.com
Also, one can decipher that, during times of reform the growth of GDP and hence the growth of stock market returns, both remain rather restrained. However, a decade after the reform period, the growth of the economy and the growth of the stock markets both propel together.
Indian stock exchanges are on their way to witness the golden decade: 2021–2030, are you ready to participate?
