GDP: What is it? How is it calculated? How a change in GDP affects your portfolio?

Any change in India’s GDP can influence your investment portfolio directly. When the GDP goes up, it can have a positive impact on your investment portfolio and vice versa.

How does change in GDP affect your investment portfolio

The GDP of a country represents its economic growth, and also the spending power of its citizens. So, the performance of your investment portfolio will depend on India’s GDP growth. In this article, we will understand what GDP is, how it is calculated, and how a change in GDP affects your investment portfolio. Let us start with the basics.

What is GDP?

The GDP or Gross Domestic Product of a country is the total value of the goods and services produced during a specific period. In India, GDP data is calculated for every financial year, from April 1 to March 31. The data is released on a quarterly and yearly basis. 

GDP data is an indicator of the economic health of a country. A positive GDP growth rate indicates that the economy is expanding and doing well. On the other hand, a negative GDP growth rate indicates that the economy has contracted and is not in the best of health.

In a developing economy like India, a high GDP growth rate is required to meet the growing needs of the huge population. We can achieve it by making big investments in building infrastructure such as roads, railways, healthcare, education, etc.

How is GDP calculated?

There are three ways of calculating the GDP of a country:

three ways of calculating the GDP

(Source: https://www.businessinsider.in)

Irrespective of the method used, the value arrived at should be the same.

How is GDP calculated in India?

In India, GDP data is compiled and prepared by the National Accounts Division (NAD), which functions under the Central Statistical Office (CSO). The CSO under the Ministry of Statistics and Program Implementation (MoSPI) releases the GDP data.

Related: Investment tips to prevent the falling GDP from affecting you

GDP calculation in India

GDP calculation in India

(Source: https://www.businessinsider.in)

As seen in the above image, India uses two methods to calculate its GDP.

Expenditure method

The expenditure-based method indicates how the different areas of the Indian economy are performing.

  • Private consumption represents the amount spent by households on the consumption of goods and services.
  • Gross investment represents investment made by the private sector on capital goods.
  • Government spending indicates the amount spent by the Government for various purposes such as paying salaries to employees, pensions, subsidies, running welfare schemes, etc.
  • Net exports represent the difference between exports and imports.

Related: Your savings can boost India’s growth; here’s how

Value Addition Method

The Gross Value Addition (GVA) Method or Value Addition Method is another method used by India to measure GDP. Each sector of the economy generates value addition as it moves through the supply chain. The GVA method measures GDP by calculating this valued addition by taking into account the following eight sectors:

 

  • Agriculture, forestry, and fishing
  • Mining and quarrying
  • Manufacturing
  • Electricity, gas, and water supply
  • Construction
  • Trade, hotels, transport, and communication
  • Financing, insurance, real estate, and business services
  • Community, social and personal services 

While calculating GDP, the nominal GDP is calculated first. It is then adjusted to account for inflation, and the real GDP is arrived at.

India’s GDP in the last few quarters

India’s GDP in the last few quarters

Source: https://www.indiamacroadvisors.com/page/category/economic-indicators/gdp-business-activity/gdp/)

The above image shows India’s quarterly GDP data for the last three years. The first quarter of 2020 saw positive growth. After that, COVID-19 struck, leading to negative growth for the next two quarters. In the last quarter of 2020, the Indian economy recovered from the impact of the pandemic and posted a positive growth of 1.6%.

India’s GDP growth over the last decade

India’s GDP growth over the last decade

(Source: https://www.indiamacroadvisors.com/page/category/economic-indicators/gdp-business-activity/gdp/)

As can be seen in the above chart, India’s GDP was growing at a higher rate, every year, from 2012 to 2016. However, from 2017, the growth started slowing till 2019. At the start of 2020, the impact of COVID-19 made matters worse.

How a change in GDP affects your investment portfolio

The general rule everywhere is that the stock markets are directly correlated with the GDP of a country. India is no exception. As markets are directly correlated with the GDP, in a way, your investment portfolio is also directly correlated with the GDP.

Since there is a direct relationship between the GDP and stock market:

 

  • A positive change in the GDP (a higher GDP growth number) will invigorate the stock markets, and as a result the market will go up. If the stock market moves up, it will impact your investment portfolio positively.
  • A negative change in the GDP (a lower GDP growth number or a GDP contraction) will certainly not go down well with the stock markets. As a result, the market will go down. If the stock market goes down, it will impact your investment portfolio negatively.

Relationship between India’s GDP growth and NIFTY 50 Index

Relationship between India’s GDP growth and NIFTY 50 Index

(Source: https://twitter.com/nitinbhatia121/status/1226029585474568192)

As can be seen from the above graph, there is a positive correlation between India’s GDP growth and the NIFTY 50 Index:

  • During 2004-2008, India’s GDP grew at a high rate of around 8% p.a. In this period, the NIFTY 50 Index went up from 2000+ to 4000+. Your investment portfolio would have given good returns during this period.
  • In 2008-2009, the sub-prime crisis struck in the US and had implications around the globe. During this period, India’s GDP growth fell from 8% to around 3% and the NIFTY 50 Index corrected from levels of 4000+ to around 3000. It would have impacted your investment portfolio negatively during this period.
  • The GDP recovered between 2009 and 2011 and so did the NIFTY 50 Index during this period. Your investment portfolio would have also recovered.
  • In 2011-2013, GDP growth fell due to factors like high crude oil prices, high inflation, European debt crisis, etc. The NIFTY 50 Index also saw a correction during this period. Your investment portfolio also would have gone down.
  • During 2013-2018, the GDP grew well and once again touched the 8% mark. During this period, the NIFTY 50 Index also did well. Your investment portfolio would have given handsome returns during this period.
  • The direct correlation between the GDP growth rate and the NIFTY 50 Index seems to have faltered in the last couple of years. In fact, there has been a big divergence between the two. So, despite the GDP growth going down, your investment portfolio would have given positive returns.

Divergence between GDP growth and stock markets

As seen in the above chart, the correlation between GDP growth and stock markets is usually direct, but that is not always the case. During 2019, the GDP growth and the Nifty 50 Index went in opposite directions, and this phenomenon continued in 2020 and 2021. Such a scenario can happen due to the following factors:

Forward-looking stock market: Stock markets are always forward-looking. So, even though the GDP growth number is low at the moment, the stock markets are factoring in good GDP growth in the future, and are hence trading at higher levels.

High liquidity: Central Banks and Governments across the globe, including India, have undertaken various stimulus programs in the last year and a half to mitigate the impact of COVID-19. This has led to cash landing in the hands of people. Most of this money has been invested in the stock markets, leading to markets trading at higher levels.

Lack of investment opportunities other than equity: To mitigate the impact of the pandemic and to kickstart the economy, the RBI cut interest rates aggressively. As a result, banks reduced their fixed deposit rates to multi-year lows. Gold went up initially when the pandemic struck, but it has corrected and has been stagnant since. As a result, Indian retail investors don’t have better investment options apart from equity. Hence, most investors have invested in equity, leading to the NIFTY 50 Index moving higher.

Foreign fund flows: Apart from Indian retail investors, even foreign institutional investors (FIIs) have invested huge amounts of money in Indian stock markets in the last one year. This too has led to the NIFTY 50 Index moving higher.

Better profitability of companies: The pandemic has affected all of corporate India. The informal economy, SMEs, MSMEs, and unlisted companies continue to suffer. But large listed companies have managed to tide over the slowdown faster and better. As a result, the profits of large listed companies have grown well and their share prices are higher, leading to the overall NIFTY 50 Index going up.

Divergence between GDP growth and stock markets is temporary

We saw how there can be a divergence between the GDP growth rate and the stock markets. But this kind of divergence is temporary and will get corrected at some stage. In the future, at some point, either the GDP growth rate will bounce back and the Indian economy will once again revert to a high GDP growth rate as earlier, or the stock market will correct in sync with the low GDP growth rate.

The probability of India’s GDP growth rate going up is higher than the stock market going down. Still, only time can tell what exactly will happen. What seems certain is that, over time, the GDP growth rate and the stock markets will once again have a direct correlation.

Last words

At the moment, even when the GDP growth is low, you would be enjoying good returns on your investment portfolio. But this may not last long, so let’s hope that India’s GDP growth bounces back quickly so our current investment returns stay and continue growing in the future. In the long run, appropriate asset allocation will make sure that you earn optimum returns on your investment portfolio even when the GDP growth is low. During such times, when the equity markets are not doing well, the debt and the gold portions of your investment portfolio can deliver decent returns. So, ensure appropriate asset allocation to equity, gold, debt, etc., so that you continue earning optimum returns, irrespective of the GDP growth rate.

Related Article

Premium Articles