Stock market indices have little to say about economic growth
Share prices do reflect the profits of companies but linking them to an economy’s health is fallacious
Stock markets are an enigma from which there is little escape. At times, it seems as if the S&P BSE Sensex and NSE Nifty have become synonymous with everything that is happening in the country, including events that transcend the economy. High readings of the purchasing managers’ index (PMI) are routinely interpreted as a sign that the economy is buoyant, and this leads to stock-index gains. Surprise news on election outcomes or of tighter capital norms for lending applied by the bank regulator can create an upheaval as share prices respond. These are micro responses that are discussed endlessly in the media on a daily basis. But the bigger picture often painted relates to the state of the economy. It is often assumed that a rising stock index is indicative of broad confidence in the economy and acts as a foreteller of its performance. How far is this true?
A stock index represents the shares of a specific set of companies. The Nifty’s formula includes 50 such firms. Therefore, when the Nifty moves up by 5%, say, it is akin to saying that the cumulative market value of the shares of these 50 businesses has risen by 5%. This being so, using this metric to represent the entire economy is an overstretch of the logic of representation. The economy is much bigger than these 50 firms (30 in case of the Sensex). Even indices that include the country’s top 100 or 500 companies cannot represent all commerce across the economy. While the market value of these businesses is very large and all big news developments that impact the economy also tend to affect these indices, at least for a few trading sessions, they do not form any kind of representative sample.
Those who swear by markets are usually driven by Adam Smith’s version of them. Many cite the ‘efficient markets hypothesis’ which argues that publicly traded equity prices take into account all possible information on economic conditions and prospects in real-time and so stock-price trends can tell us how the economy is faring in the medium term. There can be short term variations due to announcement or news effects, but, at the end of the day, an equilibrium will reflect the state of an economy. Or so goes the argument.
Let’s map India’s GDP growth rate against important business numbers. For a practical comparison, apart from the Nifty, let’s also look at growth in the net profits of Nifty companies. Stock prices, after all, are supposed to reflect the financial position of these companies as measured by their profits.
If we map out changes on three major variables—GDP growth, the Nifty and net profits of this index’s constituent companies—the picture that emerges is mixed. Take the first two. In 2015-16, when the economy did very well, the Nifty declined by nearly 9%. In 2020-21, the pandemic caused a GDP contraction, but the Nifty registered its highest increase in a decade. In 2022-23, a GDP growth rate of 7% was accompanied by a marginal decline in the Nifty. The coefficient of correlation between these two variables was -0.56. This makes it hard to convincingly argue that stock market movements reflect the overall growth of our economy. In fact, a negative correlation means that high growth in one variable tends to go along with low growth in the other.
However, a strong link is seen between the latter two variables; that is, when Nifty movements are compared with growth in the earnings of its component companies (as represented by net profits). This is only to be expected, as there is a direct connection between the market valuation of a company and its performance in terms of earnings. Here, the coefficient of correlation is a high 0.79.
Another indicator we can use is the elasticity of Nifty changes to profit changes. This shows responsiveness. Excluding 2016-17, which was an outlier in terms of company profits, affected as it was by a demonetization slowdown, this elasticity has been as high as 2.31. This means that the stock index tends to increase by more than a commensurate increase in net profits.
This analysis argues for moderation in how we interpret stock index movements. They certainly reflect the health of listed companies, especially constituents, which is logical. The profit orientation of stock markets is not in doubt. But extending the explanatory power of index movements to cover the growth prospects of an economy is inadvisable.
In case we spot an occasional lockstep, it would be more on account of a coincidence than any causal relationship. Hence, while indices may rise in response to dribs and drabs of good news on some aspect of commercial activity in the country, we can expect them to revert to their mean levels soon. This phenomenon is visible whenever there is news on monsoon prospects, with the Nifty going one way or another and companies related to the farm sector affected more than others.
It would be tempting to conclude that analysts tend to exaggerate the role of stock-index movements when they project the course of an economy. On a lighter note, it could even be said that an excessive emphasis placed on market indices by the media does us a favour, as it forces us to place index movements in the context of the bigger picture— which is the country’s economy.
These are the author’s personal views.
At a time when the world is grappling with shifting global narratives and macroeconomic challenges, India is experiencing a remarkable transformation. Strong demand, resilient supply chains, relentless innovation, rapid digitization at scale, energetic entrepreneurship and a conducive policy-and-investment climate are shaping a new wave of global optimism over India. From governments across Europe and the US to power centres in the Global South, India’s name resonates in discussions on alliances and strategic partnerships. ‘Incredible India’ is now being seen as ‘Inevitable India.’
Hence, it’s no surprise that Goldman Sachs forecasts that India could become the world’s secondlargest economy by 2075, with its GDP potentially reaching $52.5 trillion, trailing only China’s projected $57 trillion. EY predicts that India’s GDP will grow sixfold to $26 trillion by 2047, the 100th year of Independence, while Martin Wolf of the Financial Times sees India’s purchasing power surpassing that of the US by 30% by 2050.
But the narrative of an ‘Inevitable India’ isn’t just about numbers. It’s about a qualitative and inclusive digital transformation reshaping the nation’s social, economic and cultural fabric. With over 1.2 billion internet users, the third-largest startup ecosystem, a $250 billion technology industry and a 5 million-plus technology workforce, India is transforming itself into a young, vibrant and tech-savvy digital economy where no one is left behind. That is the real highlight of India.
Innovation in the West often caters to the top of the pyramid, focusing on the best before trying to reach out to the rest. India, however, has forged its own path in innovation, starting from the bottom and working its way up. This approach is incredibly challenging, especially given the complexities of a billion-plus population, diverse languages and cultures, and high levels of illiteracy at the grassroots. Many experts dismissed it as a ‘Mission Impossible.’ Yet, India has defied those odds to make it possible.
Over the past decade, India has invested well in creating the world’s largest Digital Public Good (DPI) infrastructure, establishing digital highways that connect the entire country and facilitate the delivery of essential services—from financial transfers to life-saving vaccines. This infrastructure is built on robust design principles, emphasizing interoperability, an open ecosystem and inclusive scalability from the outset.
India’s DPI could serve as a valuable case study for the world on how best to build inclusive technology in this age of artificial intelligence (AI). It demonstrates the importance of prioritizing open ecosystem-driven approaches (making it hard for monopolies to emerge), interoperability and inclusivity right from the start. This has become even more essential as AI continues to advance rapidly, promising to reshape almost everything it impacts, from global supply chains to the dynamics of global leadership and influence.
It is heartening to see these principles being applied to the recently launched India AI Mission. Government support for the development of local compute capacity, data systems, models, use cases and talent underlines the need for India to democratize AI from the very onset.
In sum, the true measure of India’s technological prowess lies not just in its success stories, but in the way we have harnessed technology at scale to address the pressing needs of our vast and diverse population. Most importantly, in the way we have driven innovation to solve last-mile challenges so that nobody is left out of the benefits that a digital economy has to offer.
In India, we do not obsess about technology. We obsess about what it can do and the impact it can create at scale. This is the single biggest lesson the world must learn from India.
As we move beyond hype and towards reality, the next few years will be dedicated to harnessing AI’s capabilities and putting them to work. Our primary focus will be on identifying significant problems that AI can solve, and deploying it at scale. This shift will prioritize return-on-AI-investment, with a growing emphasis on governance and security as such technology becomes pervasive.
This is where India’s DPI learnings can be of value to other countries. Impact creation has long been the focus of India’s digital transformation journey. From using deep-tech, satellite imagery and AI to improve agricultural productivity to deploying tele-medicine solutions to bring healthcare to the remotest corners of the country, India has demonstrated how technology can be a powerful tool for inclusive growth.
As many countries grapple with an economic slowdown and productivity decline, they are expected to adopt AI at scale to boost output. India is prominently positioned to help shape AI roadmaps that focus on inclusion and public impact. Learning from the development and populationscale deployment of technologies like Co-Win for vaccination and the Unified Payments Interface (UPI) for online bank transfers, India offers a narrative in which digital facilities are offered by a broad ecosystem and not by private monopolies. From climate change to healthcare for all, this approach can tackle some of the world’s steepest challenges.
As I look at the future, I see an India that is not only a tech superpower, but also a beacon of hope for technology resilience, innovation and determination. In other words, an India that is inevitable and unstoppable.