GDP and the market relationship is always less talked about. But both have always been correlated. Here market means the amalgamation of all the companies at a place, region or a country i.e. primarily stock market. When the GDP of a country does well, its market performs well and vice-versa. But have you ever wondered why it is so? This article is an attempt to figure out the reason behind this and to analyze the correlation between the market and the GDP. The analysis will reveal the correlation between NIFTY 50 and the economy.
Factors affecting GDP
GDP of a region/country by definition is the summation of the monetary value of all the finished goods and services within a period within the boundary of the region/country. Mathematically this can be represented by:
GDP = Consumption(C) + Govt. spendings(G) + Investment(I) + Net Export(NX)
Where, Net Export(NX) = Total export – Total Import
Whenever GDP increases, it increases because the summation of all four components (C, G, I & NX) increases. Now, let’s figure out what will be the effect of increases in each component on the market.
An increase in consumption will imply that people are buying more goods and services which means that the factories are producing more. This in turns increases the performance of the factories and thus impacts the market positively.
Investment in a country is done on the basis of its future potential. A country that has more potential to perform in the market is bound to attract more investment. Primarily, this investment is done in the market from where the investors can reap out the benefits of the potentials. This investment not only increases the GDP of a country but also increases the market worth.
According to the Ministry of Statistics and Programme Implementation, Indian govt. spend 4656.43 INR Billion during the 3rd quarter of FY 2019-20 when the market was at its peak. Whereas, Government Spending in India decreased to 3807.47 INR Billion in the first quarter of 2020 from 3877.29 INR Billion in the fourth quarter of 2019. So, the government also tends to spend more when the market is performing well.
Net export is the parameter to determine how much a country is exporting to the outside. When the demand for a country’s goods and services increases because of factors like currency exchange rate, factor endowment, trade policy, inflation, etc. it tends to produce more and more to satisfy the demand. This helps the market by increasing the revenue and profit for the industries. And so the market is also positively impacted by the increase in net exports.
Finding the mathematical relation
Getting the idea that the market and the GDP are interdependent, finding the mathematical relation was the next step. For the purpose of finding a correlation between the two, the performance of the market can be quantified into the performance of stock market indices whereas for GDP we have the quarterly release data from RBI. 95 such quarterly data points are collected. For the market, the quarterly closing values of the NIFTY 50 index are taken and for GDP, the data is taken from the RBI quarterly report. The reason to make quarterly data instead of annual are:
- It reduces the effect of an overreaction of the market in a quarter. For example, the NIFTY 50 index slumped in the last week of the last month of the fourth quarter and closed at 8597 on 31st March 2020. So, this cannot be indicative of the whole year performance. That’s why taking the quarterly data will minimize the error caused by the overreaction of the market.
- The more, the merrier. Taking the quarterly data also increases the number of data sets, 4 times more than the annual data sets, which also helps to build an efficient mathematical model.
The data that are taken are from June 1996 to December 2019.
The result of the linear regression analysis of those data are depicted in the below graph.
GDP( in rupees crore) = 287.29*(NIFTY 50 Index) + 99,823
The R² value of the above regression is 0.9252 which suggests that the line highly fits into the graph whereas the P-value of the above regression was 0.039 which suggests the validity of the regression model.
As India is targeting for $5 trillion economy from its current estimated status of $ 2.8 trillion, it will have to grow at the rate of around 9% to achieve the target by 2024. To achieve such ambitious target, India has to address its issues which are creating hindrance to its market. As the market and GDP are highly correlated, it will also pave the path for GDP growth.
As per the model, if the GDP is $5 trillion, the NIFTY 50 index will be at 1.31 lakh level. That’s why Nagaraj, a professor of economics at the Indira Gandhi Institute of Development Research, said “with the growth rate slumping, the goal looks unimaginably ambitious.”
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