Stock market growth mirage

The stock market is booming, and the KSE 100 index has almost doubled in the past year. The market is at an all-time high, breaking records. This has excited a small community of investors and they have every reason to celebrate, as the market has finally performed well after many years.

However, it is crucial to differentiate between real economic performance and a booming stock market, as they don’t always move in tandem. This appears to be the case in this boom. In the past few years, while the real economy was performing, the real estate market was booming, but the stock market’s performance was lacklustre. Now, it is catching up.

To give some perspective, despite the index gain, as of Friday’s closing, the last 10-year Compound Annual Growth Rate (CAGR) for the KSE 100 is 10.6%, which doesn’t even cover headline inflation of 10.7% over the last decade. Thus, the market still has some catching up to do.

That said, one must note that the stock market rise is not a barometer of the underlying economy. Real GDP growth is a better indicator, and within it, the quality of growth matters. This helps gauge overall employment and small business growth.

The numbers indicate that growth is missing, consumer discretionary spending is shrinking fast, and investor confidence in the real economy is low. The provisional GDP growth is at 2.38% this year, following a contraction of 0.2% last year.

Sectoral numbers paint an even more dismal picture. For example, sales of four-wheelers (cars and SUVs) in the first eleven months of FY24 are the lowest in over 15 years. Sales of two and three-wheelers are at nine-year and over fifteen-year lows, respectively. Tractor sales are also at a nine-year low.

The construction sector is similarly struggling, with local cement sales at a seven-year low in the first eleven months of FY24. The steel industry is facing similar issues, though specific numbers are not publicly available. Sales of white goods are no different, and doctors report that people are postponing necessary medical procedures due to a lack of funds for healthcare.

Energy consumption in the transportation sector is also discouraging – high-speed diesel sales are the lowest in over 15 years, while petrol (motor spirit) sales are at a seven-year low.

Consumer discretionary spending is rapidly shrinking. Many households have little left to spend after meeting basic expenses due to eroding real disposable income. Investor confidence is also shaky, as evidenced by a 50-year low investment-to-GDP ratio, and there is no cause for celebration in terms of foreign direct investment.

The issue is fiscal, with the fear of taxes keeping investors at bay. The stock market welcomed the budget because earlier proposals for higher taxation on capital income were not imposed, and they expect the IMF programme to roll out in time.

However, the imposition of taxes is a fiscal necessity. The government doesn’t have enough money and must impose more taxes sooner or later. The revenue targets agreed with the IMF are not adding up. The gaps will soon become visible in the upcoming year, and the IMF may ask for triggering contingencies, which would have inflationary consequences. Ending sales tax exemptions and higher Petroleum Levy (PL) will also have an impact on monthly inflation readings.

Currency pressure is also likely, and a few percentage points of depreciation cannot be ruled out. Therefore, the decline in interest rates may be slower than what market participants expect. It won’t be long before reality sets in, and the fear of taxation may hit stock investors again.

The focus should be on real economic indicators. Almost two-thirds of the KSE 100 index comprises of banking, energy, and fertilizer businesses. The energy sector is performing due to a reduction in circular debt growth, resulting in improved cash flows for energy companies. However, this is happening due to successive increases in electricity and gas prices, which are slowing the real economy.

The banking sector’s gains are due to high-interest rates and growing government domestic debt, largely financed by commercial banks. They are making money at the expense of other sectors, which are slowing down due to higher interest rates and less allocation of banking loans.

In the fertilizer sector, rising prices are due to input price revisions with the producers’ margins largely intact, but farmers’ ability to consume fertilizer is likely falling.

In essence, the performance of these sectors is due to factors that are slowing down the economy. The economy seems trapped in low growth until the entire fiscal framework is restructured, which this government apparently has no intention of doing.

Thus, whether the KSE 100 index reaches 80,000 or 120,000 points, it means little if the real economy is not revived. The government must navigate a narrow path in the IMF programme, with no meaningful support from friendly countries. The story will likely continue into the next fiscal year, with low growth and high unemployment being unfortunate outcomes that cannot be offset by a booming stock market.

Copyright Business Recorder, 2024