Does stock market investing helps in growth of the economy or is it a indicator of the state of the economy? If consumers are allocating surplus funds to stocks and mutual funds instead of consumption, isn't that paradoxically harming the economy?

This is a good question and that's the reason for me to answer.

A word of caution - we have to dive a little deeper down into the fundamentals of economics to understand the subject and get a proper answer.

My answer to the question - No, I do not think that stock market investing benefits the larger economy in a major way. Does it reflect the state of the economy? My answer is again “No”. I strongly believe that stock market investment and mutual fund investments are largely detrimental to the economy and wasteful investments in the Indian context. It neither pushes consumption nor helps in capital formation. It doesn’t even help in industrialization. I know with this statement of mine, there will be several hands raised to challenge my argument. I would say - please hold on.

It is estimated that only 3% of Indian households are actively investing in the stock market. This seems to be low if we compare it with the developed economy.

• United States of America - 55%
• United Kingdom - 33%
• China - 13%

Does it signify that to be a developed economy more households should invest in the stock market? Not necessarily. Let me explain the stock market investment mostly bank of two sets of parameters. 1. Bank Interest Rate and 2. Per capita Income leads to disposable income in conjunction with purchasing power.

Let’s take the example of the US. Where in general Federal interest rates are 1% or below. As such depositing money in the bank is not a very attractive idea as the yield is very low. So people have to look for alternate investment opportunities. And that is the stock market investment to get a higher return. The US also satisfies the second condition of high per capita income and reasonably stable purchasing power. High per capita income is a very essential condition since you have to have sizable disposable income that could be spared for investment.

The GDP per capita (current US$ 2022) - United Kingdom is $ 46,125.3. The GDP per capita (current US$) - United States is $ 76,329.6. For China, it is $12,720.2. For India, it was $2,410.9 in 2022. These figures perfectly match the percentage of share market investment share above. So it is largely dependent on the per capita income.

Interest on deposit accounts in China from 2009 to 2022

The interest on bank deposit rate in China has been stable at 1.5% since 2015. This together with the increase in per capita income has contributed to the growth in the share of households investment in the stock market. These two factors largely contribute to the growth in stock market investment. If we leave aside 2021 the GDP growth rate of the US has been around 2% over the last twenty years. Over the last 20 years, the GDP growth rate of the UK has also been around 2%, mostly below 2%. But both for the US & UK we see very high shares of household investment percentage in the stock market. This clearly proves that the growth in the share market investment doesn’t have any correlation with the GDP growth. Neither does it contribute to the GDP growth, otherwise, the US & the UK would have achieved very high GDP growth. Nor does it contribute to the industrial growth. Because high industrial growth would have reflected in high GDP growth.

The economies like the US & UK have very limited scopes left for investment in the industrial segment. There is very little credit demand from the banks. So the Federal rate has been mostly very low. However, we have seen a very high interest rate in 2022. The benchmark Federal borrowing rates have been tagged between 5.25%-5.5%. This is predominantly to cut down the inflation fuelled by the increase in currency volume by $ 5 Trillion in 2020–21. But these increases in the interest rate have also dealt a severe blow the US banks. Sometime back one of the largest banks in the US, the SVB went for bankruptcy.

The problem for the Indian banks is also very complex. A very large share of their capital has been eaten up by writing off bad debt and fresh creation of NPA. Indian banks have already written off around 14 lakh crores of bad debt in the last ten years. Even after this, the NPA is hovering around 6 lakh crores and another 3–4 lakh crores stressed assets. This has created a tremendous liquidity crunch for the banks. Secondly, they have been hit by a lack of savings mobilization.

As per the Oxfame report the top 10% of the Indian population holds 77% of the total national wealth. The balance of 90% population holds only 23%. The top 5% richest Indians own more than 60% of the country’s wealth. With so much accumulation and concentration, savings and capital formation are largely dependent on the top 10% of people. However, this section of people is going for investment in the speculative market.

NYSE Composite Index is 16,770.45 as of 22nd December last closed. The calculation of the New York Stock Exchange index is a little bit complex. So I would avoid going into the calculation part. However, the NASDAQ 100 Index (NASDAQ Calculation) comes close to the overall NYSE composite index. (this section is for people who are aware of the stock market indices)

In India, there are two prominent Indian indexes - Sensex and Nifty. Sensex is the oldest market index for equities; it includes shares of the top 30 firms listed on the BSE. Sensex was created in 1986 and provides time series data from April 1979, onward. We have two major stock exchanges the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE).

Another index is the Standard and Poor's CNX Nifty. Nifty includes 50 shares listed on the NSE. It was created in 1996 and provides time series data from July 1990, onward. Basically, you can say that Sensex provides the BSE Index and Nifty provides the NSE index. However, all major shares are listed in both BSE and NSE.

S&P BSE Sensex closed at 71,106.96 on 22nd December. Whereas the benchmark Shanghai Composite Index closed at 2,905.79. Shanghai Composite Index is the main index of the Chinese stock market. What I wanted to point out is the Sensex index is much more inflated looking into the size of the economy. Just compare the Indian Sensex and Shanghai Composite Index and you will understand whether the stock market in India represents the state of the economy or not. Indian stock market index is very highly inflated. In 2008–09 when the Nifty and Sensex crashed by 50% points, the Indian economy didn’t crash. Following are the GDP growth rates for two consecutive years when the world economy crashed.

You can see how the US economy crashed in 2008 & 2009. Their share market crash and economy crash picture matches. But the Indian economy managed to grow by 3.1%. And in 2009 the GDP growth jumped to 7.9% despite the Nifty and Sensex crashing by 50% points. Can you see the disconnect? When it comes to the Indian economy we can not rely on the stock market index to throw a reliable picture of the economy. So in the Indian context, we have to see both the Nifty and Sensex detached from the actual position of the economy. Both the fall and the growth of the Indian stock market are not reliable indicators of economic growth or fall.

I have already shown above in the case of the US and the UK markets that a larger volume of investment in the stock market does not help the economy to grow. Despite 55% households of in the United States of America investing in the stock market, their GDP growth has been restricted to around 2% over the last 20 years. In India, the bank interest rates are falling. So more and more people are being compelled to look for high-yielding investment options. However, even though investments in mutual funds and stock markets have gone up the investments in IPO & FPO are less than 1% of total investment. So practically its contribution to industrial growth or in capital formation is negligible. Neither of these investments could be considered savings mobilization. 99% of investment goes into the trading of equities which doesn’t help any production, demand, or consumption growth nor does it help in capital formation.

The stock market investment generates some tax revenue for the government. The average annual return from the stock market investment in India is around 10%. To that extent, it could be helpful for the economy. However, most of the return is re-invested, so it doesn’t help in demand generation. So in my personal view, I believe that increasing the volume of stock market investment hardly helps the economy. Rather it is a sign that the economy is losing its shine and people are forced to invest in the speculative market. It could be detrimental to the banking system.

So I would stick to my stand that I strongly believe that stock market investment and mutual fund investments are largely detrimental to the economy and wasteful investments in the Indian context. Another very big fallacy of the stock market growth is that it inflates the rate of certain equities beyond any rational. Which is grossly detrimental to the economy as well as to the investors - both individual and institutional. We get a completely distorted view of the market cap.

The Indian banking system is getting hit on multiple heads. Largescale capital demand and investment are being met by FDI, FPI, external debt (soft loan at much lower interest) loans from the World Bank, IMF, ADB, etc. So the Indian banks lose out on interest earning. The pressure of writing off bad debt and the pressure of NPA. The low savings mobilization and poor credit demand. The usual banking functions have also been taken over by the digital payment mode. Plus over-investing in inflated equities puts the bank, financial institution, EPFO, etc under great risk. The more risky part is that these investments are not through the IPO/FPO route. They are through the trading route. The question also speaks about increasing consumption. Unfortunately, the top 10% of richest people in India contribute only 4% of GST collection. This is despite them holding 77% of the total national wealth. This means they are neither helping in consumption nor in generating tax revenue.

My answer ends here. However, people can go a little deeper into the subject if they want to build up a composite understanding of the subject. We have three different kinds of foreign investments - FDI( Foreign Direct Investment), FPI ( Foreign Portfolio Investment), and FII (Foreign Institutional Investment) FDI is structural and a long-term investment by a firm or individual into business interests located in another country. I said FDI structural as it decides the ownership structure or format of the organization securing operational and management control/stake. And it is less volatile in the sense that the withdrawal of FDI is a complex matter.

However, FPI and FII investments are floating in nature, which means they are volatile and their withdrawal could be sudden.

Foreign Portfolio Investors (FPIs) are those foreign investors investing in Indian financial assets, including shares, bonds, debentures, etc. FPIs include investment groups of Foreign Institutional Investors (FIIs), Qualified Foreign Investors (QFIs) subaccounts, etc. Individual investors do not qualify for investing directly under FII. They have to invest through the Subaccounts routes. Subaccount means a person resident outside India, on whose behalf an FII proposes to invest in India. FPI includes all investment categories which makes portfolio investment including FII, small investors included under QFI, and miscellaneous investment entities. QFI means a person who is either a resident of a country that is a member of the Financial Action Task Force (FATF) or a member of a group that is a member of FATF; and/or a resident of a country that is a signatory to IOSCO’s MMOU or a signatory of a bilateral MOU with SEBI.

FPI = FIIs + QFIs and other small investors.

The FII invests on behalf of its Sub-account), Qualified Foreign Investors (QFIs) as well as Non-Resident Indians (NRIs). The following categories of investors fall under the FFI - Overseas pension fund, mutual fund, investment trust, insurance company or reinsurance company, International or Multilateral Organization/agency, Foreign Governmental Agency, Sovereign Wealth Fund, Foreign Central Bank Overseas asset management company, investment manager or advisor, bank or institutional portfolio manager.

Anyway, foreign investment is not part of the question So I am not going deep into it and its impact on the stock market as well as on the economy.

 Yellen says China is too big to export its way to rapid growth,  How far this is true

This question is not on me. I actually borrowed this question to answer. U.S. Treasury Secretary Janet Yellen said that China is too large to try to export its way to rapid growth and would benefit by reducing excess industrial capacity that is pressuring other economies. Janet Yellen did her studies at Harvard University, the London School of Economics, the University of California, Berkeley, the National Bureau of Economic Research, and the Brookings Institution in the field of Macroeconomics and Labor economics. So far her alma mater is concerned nobody would dare to say that she doesn’t understand economics, the way quite often people say that our honourable finance minister doesn’t understand economics or the economy.

I agree her statement would take many by surprise and possibly many would get antagonised.

Meanwhile, I believe part of your question

“

China should import its way to rapid growth like the US” is incorrect, Janet Yellen has not made any such suggestion.

As such I believe Janet Yellen didn’t say anything wrong when she said that China is too large to try to export its way to rapid growth and would benefit by reducing excess industrial capacity that is pressuring other economies. In my view, the Chinese economic model has already created a huge disparity which the US economy had gone through post World War II, very specifically since the sixties.

China must be having great economists in its thin tank to rise so fast. But for them also it's not possible to defy the law of economics. Let me go fundamentals of economics to explain this.

Forewarning

- since this answer will dash into the fundamentals of economics, it could be a little subject-heavy. However, I strongly believe that economics is a very easy subject if we pay a little attention.

In my evaluation also it is not possible for China to achieve rapid growth from where it is standing now and even a growth rate of growth rate of 5-6% will be extremely difficult.

In my view also, the Chinese economy will have to struggle to achieve anything above 4% real volumetric growth. Volumetric growth is a little different than value-based growth when the GDP is converted into money value. For example, you manufacture 1000 units of automobiles and sell them for a value of Rs.50 Cr. Suppose you produce the same number of cars, but increase the price and sell them for Rs.55 Cr. with 105 increase in price. So there is no volumetric growth in production, but there is a production growth when we go by value-based evaluation.

Now this value-based growth could be achieved in another way. Instead of increasing the price, you could go for the production of more number upper-segment cars. This is done under three circumstances - 1. When there are constraints in increasing manufacturing. 2. There is no scope for increasing your market share in numbers or volumetric terms. 3. There is no market growth in terms of buyers. However, this value-based growth also may not be possible if there is no increase in purchasing in the market. As such market or market growth always means purchasing power and its growth.

The Chinese economy is the 2nd largest economy in the world with a GDP size of $18.560 trillion (nominal; 2024 est.).

That means if it has to grow at 6% annually it has to add a GDP of $1.11 trillion every year in simple growth. And if we consider growth compounded monthly then it has to add $1.14 trillion every year. if we look at the Chinese economy it is definitely capable of producing an additional GDP of $1.11–$1.14. However, for the next year, the same growth will be calculated on the base of $19.67 trillion. So the asking rate will only go up. The problem is sustaining the massive GDP and maintaining its growth.

Chinese President Xi Jinping speaks in Beijing's Great Hall of the People in 2017.

Lintao Zhang/Getty

The GDP compositions of China are as - Private consumption: 37.17%, Government consumption: 16.12%, Gross capital formation: 43.48% Exports of goods and services: 20.66% Imports of goods and services: 17.48% Net exports: 3.22% (2022)

United States Private Consumption accounted for 68.2 % of its Nominal GDP in Dec 2023, compared with a ratio of 67.5 % in the previous quarter. The data reached an all-time high of 68.8 % in Dec 2011 and a record low of 57.7 % in Mar 1952.

Can you see where the problem in the Chinese economy is? The problem of the Chinese economy lies in the low share of private consumption of

37.17% in the GDP composition

. Compare this with the US economy, and you will understand why China will face difficulties in sustaining GDP growth. This is despite China being a producing economy. The private consumption in China is the 2nd lowest in the world. Brunei ranks first at 27.6% ( Sept 2023). Brunei being an oil-producing country, we can understand the reason for a lower share of private consumption in GDP composition. However, Brunei makes up the loss with a GDP per Capita of 28954.06 Dec 2022. Even if the percentage is low, a higher GDP compensates for the value. But with less than half of Brunei’s (GDP) per Capita China has no way to sustain GDP growth. China’s GDP per capita was 12,621.721 USD in Dec 2023.

Now if we go extra deep the problem looks more intense. China’s private consumption as a share of GDP has declined from around 55 percent in the early 1980s to around 37 percent in 2008 (Source IMF).

What kind of economic growth is it where despite massive GDP growth and population growth, the share of private consumption has gone down drastically? There must be something seriously wrong with the Chinese economic model.

Coming to the highest contributing factor to Chinese GDP is gross capital formation which contributes 43.48%. This seems dicey.

Why is such a high share contributed by gross capital formation? What goes into it? And what are ROCE and ROA (return on capital employed and return on asset created) If the return is high then it will reflect on domestic private consumption as well as in export promotion. Whereas China’s Export-Import net gap is only 3.22% (2022)

China is focusing on gross capital formation which has driven over production.

At the end of 2023, China had the capacity to build 861 gigawatts of solar modules per year, more than double the global total installed capacity of 390 million gigawatts. Another 500-600 gigawatts of annual capacity is forecast to come online this year -- enough to supply all global demand through 2032, according to energy research firm Wood Mackenzie. The situation in China's solar panel sector may be worse, where overproduction pushed prices down 42% last year.

We have discussed volumetric production growth and value growth in the beginning. We have a reverse case here. Despite a massive production volume growth, we do not have value growth. So it will not lead to GDP growth. Though they may show GDP growth by increasing investment/expenditures in capital formation. But unless the additional capital formation doesn’t generate production growth in value terms how will the GDP growth? This is the picture of most industry sectors of China. They are loaded with overproduction capacity that can not be discharged in the market since there is no growth in domestic private consumption. Plus there is a limitation increase in export.

Export promotion is limited by existing worldwide purchasing power. The pie of the global market demand or purchasing power has not been increasing in proportion to China’s growth expectation. The following are GDP growth estimated by the IMF

Emerging market and developing economies 4%

Advanced economies 1.4%

World 2.9 %

For the year 2024, the world GDP growth is estimated at 2.9%. the emerging mater and the developing economies are expected to grow by around 4% and the Advanced economies are expected to grow by 1.4%. So China can not increase its export growth beyond 4%. Secondly, Net Exports contribute only around 3% of the GDP composition of China. The domestic private consumption of China is not increasing. How would China achieve GDP growth above 4%/ Had it been a small economy, it might have been possible as an exceptional case. But China is the 2nd largest economy in the world, it can not defy the global market depression.

Anything above the 4% GDP growth of China could be dubious.

The second thing that U.S. Treasury Secretary Janet Yellen very correctly said is that China would benefit by reducing excess industrial capacity that is pressuring other economies.

China unnecessarily disturbs other economies by offloading the additional production volume at a substantially reduced cost. It is imperative that the world economy as a whole need to grow. Without that, a big economy like China can not sustain rapid growth. This is because of the disparity. That is exactly the reason the US economy could not sustain growth beyond a period. The US economy is holding base because of high per capita income and the high share of domestic private consumption. China needs to focus on increasing domestic private consumption.