CIRCUIT BREAKER. Barometer of the economy. Really?

For long, investors have looked upon companies making up the Nifty and Sensex as the best and the brightest of the Indian economy. Novice investors are asked to invest in equities via index stocks because these companies are market leaders, with strong brands and pricing power. Analysts projecting India Inc’s profits also glibly assume that Sensex companies will expand at a multiple to the economy. But lately, all these assumptions have been proving wrong.

As the results season for 2014-15 draws to a close, it is clear that listed companies, particularly those making up the Sensex and Nifty, are lagging behind the broader economy this time around. The Sensex constituents have closed FY15 with a 2.3 per cent growth in sales and a 2 per cent fall in aggregate profits. This is in contrast to government data which shows that India’s GDP, on a nominal basis, grew at 11.5 per cent this fiscal. Sales growth for the Sensex companies for the last three quarters hasn’t exceeded 5 per cent, while nominal GDP growth has averaged 9.8 per cent.

Commentators seize upon these numbers to argue that the new set of GDP numbers are dodgy and that they do not capture the ground realities of the economy. But why can’t the opposite be true? What if the Sensex (or Nifty) companies are no longer a barometer of the Indian economy?

Breaking down the financial performance of the Sensex companies for the latest March quarter reveals that this could well be true. There appear to be two key reasons for the poor show. For starters, companies from sectors such as oil and gas, metals and mining (Reliance Industries, Tata Steel and Vedanta, to name a few) make up a fifth of the weight in the Sensex. These firms have reported steep declines in sales in recent quarters thanks to realisations being eroded by the global commodity meltdown. Being giant-sized, they chip in with 40 per cent of the aggregate Sensex sales.

Two, write-offs or other problems at their acquired foreign facilities have triggered profit drops for another set of index heavyweights — Tata Motors, Tata Steel, Sun Pharma and Vedanta, for instance. Maruti Suzuki, TCS, Infosys and Dr Reddy’s may not have made big ticket acquisitions, but they are impacted by cross-currency movements nevertheless, because of a significant forex component to their costs or revenues.

While many of these firms may indeed be market leaders in India, their global exposure ensures that they need to compete with global rivals for both market share and profits, which makes it hard to hold on to either pricing power or profitability through global cycles.

The breakdown tells us why index companies are no longer finding it as easy as before to race ahead of the Indian economy. Many of these behemoths owed their traditional ‘pricing power’ to a booming global commodity cycle, purely domestic operations or even limited competitive pressure within India. But as they scale up and venture overseas, pricing power or higher margins can no longer be taken for granted.

This reasoning explains why it may not be all that impossible for smaller unlisted firms or even the vast number of India’s small and medium scale businesses, to pip the index companies on growth. Given how important scale is to the commodity business, very few small or medium-sized firms in India are likely to be engaged in mining, metals or oil exploration. And given the costs at which he borrows, hardly any small business owner would be emboldened to make oversized cross-border acquisitions.

As the globalisation of India’s largest companies is likely to be a continuing process, both investors and policymakers may have to adjust to the fact that the Sensex or Nifty can no longer glibly taken to be the ‘barometer’ of the Indian economy. After all, the Sensex captures the prospects of precisely 30 companies while the Nifty covers 50. The database of the ministry of corporate affairs, which has been used to arrive at the new GDP numbers, captures data for about five lakh companies.

But even this is only the tip of the iceberg. At last count, the Indian economy was said to feature 48 million SMEs. More data on how they are faring and policy initiatives to address their specific problems may do more for economic prosperity than obsessing over Sensex swings.

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