Okay but laana:
Why do I need to know about GDP?
22nd May 2021
Reading time ~ 4 minutes
Hi there,
Over the past couple of days, there has been some talk about GDP forecasts and RBI's review of the economy amid Covid.
Since general concepts around these news items affect your investing journey, we thought we'll cover that in this week's okay but laana.
I never studied economics!
One of my favorite authors, Nassim Taleb (who writes on risk, mental models, uncertainty, etc.) quite openly criticizes economists. He once said: "Being nice to the wicked (or economist) is equivalent to being nasty with the virtuous."
Real talk (I studied economics, FYI).
So since we've decided to talk about GDP, we're going to try to explain it with the least amount of economics jargon possible. Here we go:
Cool, so GDP?
GDP or Gross Domestic Product is one of the most common and important metrics that is used to understand how the nation is performing as a whole (we could argue that realistically, the Human Development Index should be more important, but let's leave that for another time).
As you might agree, India produces a TON of products and services on a daily basis - from the production of coffee beans to planters, to someone building a pizza at Domino's, to Boat headphones, that bottle of Sula wine to what you might be doing on a daily basis to earn money. ALL of this adds up to measure how much India is producing as a whole, and GDP measures exactly that. It is the total amount (in rupees or dollars) of goods and services produced within India for a specific time period. You take the GDP of one period, say a quarter and compare it with the GDP of the next quarter. If the GDP increases, viola - the economy is doing great; if the GDP falls - tough luck - the economy is not doing so great. India consistently ranks in the Top 10 GDPs of the world!
Here's an explainer if you want to dive deeper.
Now, it's important to measure GDP (and some other economic factors) on a regular basis to help inform different aspects such as domestic policy, business investments, job outlook, trade, etc. Cool?
So let's look at a recent report outlining India's performance this year:
Enter: RBI's review of the economy
The RBI, on a regular basis reports on how the economy did over a specific period of time. Let's look at what it said in a May 17th report (State of the Indian Economy):
"The resurgence of COVID-19 has dented but not debilitated economic activity in the first half of Q1: 2021 - 22. Although extremely tentative at this stage, the central tendency of available diagnosis is that the loss of momentum is not as severe as this time a year ago."
Simply put, the second wave has had a negative effect on the economy, but it's not as bad as April - May 2020, when the first lockdown was ongoing. Not too bad, right?
Well, when we look deeper, RBI suggests that the effect has been in a "U" shape - the ones on the top of the U being least affected - IT, automated manufacturing - things that can be done remotely. In the well of the U are the ones that are most affected - blue-collar workers, small businesses, ones on daily wages - anyone that requires human contact to earn a living.
More so, with the looming effects of Covid, stock markets have been jittery (i.e they have seen some short-term up and downs). As expected, foreign investors took out money from the Indian markets. However, mutual funds in India have invested more money in the markets, restating their confidence in the businesses.
RBI gave both good and bad news but rightly ended by saying:
"The ferocity with which Covid has impacted this time around clearly warrant priority in policy intervention (...) The key lesson from the visitation of the second wave is vaccinate, vaccinate, vaccinate."
From a purely economic standpoint, the loss of jobs, lack of mobility, lockdown restrictions, etc. will all contribute to lower production in the country. Think about it - you used to get a weekend dinner at a restaurant - now, because of the lockdown you don't do that anymore - so the restaurant is affected, the staff is impacted, the Uber you take is affected, and everything here will have a trickling effect on how much is produced overall.
So how does the future look?
Apart from looking at past data, there are agencies (such as Moody's) that estimate economic indicators like how much consumers will spend, how much businesses will produce, how many people will have jobs, etc. to arrive at a GDP prediction for usually the next quarter or the next year. One such forecast was put out by Moody's recently:
“As a result of the negative impact of the second wave, we have revised our real, inflation-adjusted GDP growth forecast down to 9.3 per cent from 13.7 per cent for fiscal 2021 (FY22).”
As is pretty evident from RBI's report - the tragic second wave, coupled with the (needed) lockdown, hasn't been great for the economy. As a result, GDP forecasts for India in Financial Year 2022 have decreased. Moody's initially expected GDP growth to be at 13.7%, but this number is now down to 9.3% - i.e GDP is still expected to grow, but now at a lower value.
Note that Moody's says the "real, inflation-adjusted GDP" - what this means is that the value of the GDP for the quarter that it is forecasting for, has been adjusted for inflation. Let's take an example - you buy one cup of coffee in 2021 for 100 bucks. Because of inflation, in 2022 that one cup of coffee costs you 200 bucks. Now in 2022, when you're looking at coffee production in India, it will show that the production value has increased from 100 to 200 bucks. However, this is not an actual growth. The amount of coffee produced has remained the same (1 cup), it's just because of inflation that the production value has increased. Thus, in 2022, you'd have to adjust for inflation and decrease the coffee production value to 100 bucks to make it comparable. So, when you're comparing GDP among different periods, you look at the "real GDP" that adjusts the value of GDP according to inflation.
Got it, so what does this mean for me?
In the long term, your investments will usually perform in the general direction of how India performs. Usually, when GDP does well, the market cap of companies overall improves (remember market cap from Part 4?) and your shares will likely do well. If the Indian GDP is growing in the long term, the value of your investments will usually grow - and vice versa if the GDP is shrinking.
It's quite simple - when GDP increases there is more production, more spending, more investment in the country - so business will earn more - because earnings are increasing, investor confidence in the business will increase and more people will buy stocks instead of selling them - driving the stocks up (good for you if you've already invested) in the long term.
It's important to note that when you invest in stocks (either directly or through equity-based mutual funds), you usually do that for the LONG term. Small hiccups in GDP might happen, but when the general direction is positive, that's still good. Don't get intimidated by a short-term shrink.
If you want to delve deeper, check out some amazing explainers here and here.
Thoughts?
P.S: Elon doesn't stop + An update to last week's edition
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