What is market cap-to-GDP ratio? What does it indicate? Discuss with focus on India's market cap-to-GDP ratio.
The market cap-to-GDP ratio is primarily used to determine if the market as a whole is over or undervalued. It basically represents the percentage of GDP which represents the value of the stock market. A figure over 100% signifies the market is overvalued while one around 50% stands for it being undervalued. It is also known as the Buffet Indicator and for India, the ratio stands at 86%.
- The ratio is in widespread usage in the western world in developed markets where it has many uses. Many economic drivers like household income and savings, equity vehicles, consumer spending etc. have a profound impact on the market cap and make it move in tune with the GDP. Thus, it is a good measure of the economic health of the nation.
- It is a great indicator of the buoyancy of the economy as an upbeat economy will have more money in the stock market like the US where 52 percent adults own stocks.
- Furthermore, it is an excellent referral in countries where most of the business enterprises are listed and market capitalisation can be comparable to GDP.
Indian conditions do not yet qualify buffet indicator as a viable measure of Indian economic circumstances as Indians have much less equity ownership as compared to the US and other developed economies. Only 4 percent of the adult population of India owns stocks as against 52 percent in the US. Also, Indian households only allocate 6 percent of their income to equities as against 35 percent Americans. In addition, a major chunk of economic activity in India has not listed especially the large informal sector. Even a sizeable portion of successful enterprises do not prefer to be listed to avoid compliance and other requirements. Lastly, Indian economic structure is apparently different from the composition of its stock market. The share of industry, agriculture and services in GDP are 25, 15 and 60 percent respectively but the stock market is largely composed of the industries and the former two are gravely underrepresented. The Indian growth story has been shaped by the services. Thus, all links between GDP growth and corporate performance have come down in recent years. Thus, it is quite unrealistic to consider market cap-to-GDP as a robust indicator of the economic health of India.