The Economic Survey 2018-19, which anticipated India’s economic growth at 7.0-7.5% for the next fiscal year, analysed the boom in Indian equity markets and said higher corporate earnings and economic growth are important to sustain the market’s upward trajectory.
The Economic Survey was presented by finance minister Arun Jaitley in both houses of Parliament on the first day of the Budget session on Monday.
A section of the report drew parallels with a similar move in the US equities and certain key economic indicators. India’s Sensex – a gauge of top 30 stocks on the BSE – has risen 46% and 52%, respectively, in rupee and dollar terms since December 2015. US S&P 500 index has risen 45% in the same period.
While the boom in stock market has brought the price-to-earnings (P/E) ratios of India and US markets at par, the survey highlighted the state of economic growth, corporate earnings and key interest rates as three key differentiating factors between the two markets.
“The stock market surge in India has coincided with a deceleration in economic growth whereas US growth has accelerated,” said the report adding that India’s corporate earnings to GDP ratio which currently stands at 3.5% has declined since the 2008 financial crisis and real interest rates in India are near historic high levels.
In contrast, US’ corporate earnings to GDP ratio was at 9%, and could shoot higher with the legislated tax cuts in the US, besides critically low interest rates, the Survey observed.
Liquidity-driven boom
The Survey tends to highlight that India’s boom is driven by liquidity, especially with the mutual fund money flowing into stocks.
“First, expectations of earnings growth are much higher in India (at the origin of the boom in 2016-17). But by 2017-18 signs began to accumulate that the profit recovery was not obviously around the corner. At that point, second factor gave the market further impetus – demonetisation,” the Survey said.
“The attack on illicit wealth helped to level the playing field… This caused investors to re-evaluate the attractiveness of stocks. Investors have accordingly reallocated their portfolios toward shares, with inflows through stock mutual funds, in particular, amounting in 2016-17 to five times their previous year’s level,” the Survey added.
To be sure, mutual funds bought Indian equities worth a record Rs 1.13 lakh crore during the period between January and December 2017, Bloomberg data showed.
Accordingly the equity risk premium (ERP) – the extra return required on shares compared with other assets – has fallen and pushed the P/E higher, reflecting the massive portfolio re-allocation by savers towards equity and the lack of interest in other assets such as real estate and gold.
“(However) sustaining these valuations will require future growth in the economy and earnings in line with current expectations, and require the portfolio re-allocation to be semi-permanent. Otherwise, the possibility of a correction in them cannot be ruled out,” the Survey said, concluding that the rise in India stock market differed from that in developed economies.
