Number Theory | Three indicators of economic sentiment in the Indian economy

The Monetary Policy Committee of the Reserve Bank of India will hold its next bimonthly meeting exactly a week from now. The environment in which MPC will hold its next meeting is, in many ways, very different from what was the case when it last met in June.

The Monetary Policy Committee (MPC) of the Reserve Bank of India will hold its next bimonthly meeting exactly a week from now. The environment in which MPC will hold its next meeting is, in many ways, very different from what was the case when it last met in June. While there is good reason to believe to inflation might have peaked, both in the domestic and global economy, there are other economic headwinds to reckon with, especially on account of

(AFP)

Investor sentiment in equity markets

Equity markets do not necessarily move in tandem with growth performance of an economy, but they do play an important role as far as macroeconomic prospects are concerned. The wealth they generate can have significant positive or negative impact on consumer spending, especially by the rich who have a greater exposure to the stock markets. They also attract foreign capital which plays an important role in countries such as India which almost perpetually run a trade deficit. Given the fact that investments in the stock markets are made in expectation of future profits , the price-earnings or PE multiple is a good metric to track the state of investor sentiment. The PE multiple basically looks at the ratio of the price of a share to earnings (dividends) per share of a given stock. This means that the higher the PE multiple, higher is the confidence (or exuberance) in the stock market.

The PE multiple for India’s benchmark stock market index BSE Sensex was rising consistently even when the economy was caught in a slowdown before the pandemic hit. It fell during the lockdown but rose to even higher levels in the later phase. The monthly average PE multiple for BSE Sensex reached 34.4 in March 2021, its highest value since December 1994. It has fallen sharply to 21.6 by June 2022. Whether the correction in stock markets is driven by international factors such as rising interest rates in advanced economies and hot money shifting to commodity markets or a realisation that future profits are not going to be as high as earlier expectations is a question worth asking as far as domestic economic prospects are concerned. In case it is the latter, there are bound to be headwinds for investments.

Consumer sentiment

The ongoing Parliament session has seen repeated disruptions over demands by the Opposition to hold a debate on inflation. While the headline inflation print did come down for third consecutive month in June 2022 -- and so have global commodity prices in the recent past -- MPC expects inflation to stay above the 6% threshold (the upper limit of RBI’s tolerance band) until the quarter ending December 2022. It’s important to understand how inflation has impacted mass purchasing powers, and therefore aggregate demand.

A clearer answer to this question will come when the National Statistical Office (NSO) releases the June quarter GDP numbers in the last week of August. For now, MPC will have to read the tea leaves by looking at the consumer sentiment numbers. While the May 2022 round of RBI’s Consumer Confidence Survey (CCS) did show an improvement over past levels, sentiment still in negative territory. The July round of CCS will hold important insights.