Is lower GDP growth a worry?

Wed, 1 Jun Pre-Open

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Sales growth is a key variable used in projecting the future estimates for a stock. For most sectors the number is closely linked to the rate at which the economic output grows. In other words, it is the reason why investors keep an eye on the GDP growth projections. It helps them ensure that the stock estimates are well in line. Hence for an economy that has investors backing their estimates with 9%+ GDP growth assumption, lower growth numbers are often a cause for worry.

Policymakers and economists in India have been very hesitant to admit that GDP growth in the current financial year (ending March 2012) could be well below 9%. The RBI's policy of sucking out liquidity to contain inflation has been blamed for lower growth possibility. Most investors conceive the lower GDP growth prospects as a key risk to their portfolio.

Here it is important to understand that India's approach at growing its economic output is very different from its Asian peers. The government does not stimulate exports by allowing products to be priced very cheap. The value of the currency is not artificially managed to ensure higher sales overseas. The domestic savings are largely retained within the country with limited access to overseas investments. Some of these may be viewed as a conservative approach. But these approaches have so far kept India's GDP growth resilient to global shocks.

The growth obsessed Asian economies like China, Taiwan and Korea may get a notch or two higher GDP growth rates in the coming years. But not without causing irreparable damage to their economic foundation. There cannot be an investment worse than accumulating large quantities of foreign currencies that have diminishing value. Also with lower domestic investment and consumption, the countries' demographic virtues may cease to exist. All the more reason for India to believe that its growing base of working population is its biggest asset.

Coming back to stocks, we have no reason to believe that 9% GDP growth rate is impossibility for India. However, investors need to acknowledge that it would be a 'best case scenario'. And investments made with only the best case scenario in mind could end up being very expensive. Hence while marginally lower GDP need not be a worry, the assumptions for stock estimates need to be more realistic. Ones that take into account scenarios of lower global demand, higher input prices and interest rates. Most importantly, it would be best to benchmark sector and stock performances keeping long term cyclical trends in mind.