economy is at a ten-year low. Now what low growth does for a company is that it reduces its price-to-earnings ratio. Similarly, low growth in the economy will also reduce the value of the companies listed on its stock exchanges. As the growth in a company picks up and the trend of growth becomes faster, normally the P/E ratio also expands. Similarly for an economy as the growth picks up, the valuation will also pick up.
Another factor has been the governance discount. The federal government has not been able to take many growth supportive steps over the last three to four years. Various corruption scandals have shackled the government and the lack of decision making has hit the previously high-growth segments like roads, power etc. Similarly, on the central bank front there has been a credibility gap that has built up over the tenure of the last governor. I have always believed that “A smart central bank is much more important than a smart government”. With Raghuram Rajan coming as the RBI chief we now see some confidence and credibility come back for the RBI. The key will be to see what kind of government we get next year.
Positive changes in the RBI and a stable central government will lead to a revaluation of the markets. A part of this revaluation is already evident as the markets have started to build in the possibilities of a more progressive government next year.
I believe that the Indian stock markets have been held up due to various factors. Most of these are looking to reverse, going forward. The last six years have been of suboptimal returns from equities, the next five could be very different.
The author is a Mumbai-based fund manager