There is a tendency to confuse economic outlook with bullish stock markets. This is not entirely justifiable. Stock markets are fickle. They are as correlated with prospects of economic growth as, say, land prices. What they represent is the market's view on corporate profitability, a narrow segment of the economy.Thus, there are situations where the economy is in dire straits as represented by a significantdevaluation or hyperinflation.

Either of these could let off a bull run beginning from stocks of export-oriented stocks and scarce commodities and spreading to the market as a whole. In a negative sense, a rising stock market represents a transfer of wealth from the consumers to the stockholders, as rising land prices indicate a transfer to the landlord. This does not have much impact from the macro-economic perspective, so why bother about it. Its importance lies in its intangible benefits. Consumer spending increases because of the "wealth effect", as people feel richer. Corporate investment also rises because of increased availability of funds to industry. As a result, a virtuous cycle develops.

Why do stock prices move up in the first place, as they are now doing in India? Expectations of better corporate results may cause it, based on expansion of output and improved productivity. At present, it is largely hope, since only specific sectors-consumer non-durable and software -- have actually shownimproved profits.

Investment also remains restricted to replacement and not creation of new capacity. Another cause, unrelated to expectations, is the liquidity in the system. Empirically, bull runs have occurred in periods of low interest rates and surplus liquidity. The current situation in the country reflects this. There has been a bull run in bonds and even as we speak there is talk of a further bank rate/CRR cut based on low inflation.

Interestingly, tremendous surplus liquidity is driving a rally in emerging market equities across the world. This was caused partly by the US Federal Reserve, which cut its rates aggressively in the final four months of 1998, to help support international financial markets. International investors then pumped in funds into the equity markets. Domestic fiscal stimulus by governments fighting hard to kick-start their economies further increased domestic liquidity. As a result a low interest rate environment emerged.

Except in uncertain Latin America and highinflation Turkey, interest rates are below 10 per cent across the emerging-market world and headed lower. This is sharply down from the levels just six-nine months ago. As a result, the MSCI Emerging Markets Index jumped 46 per cent in the current year (an almost 75 per cent increase over nine months). Of the 28 countries covered by the Index, only three are in negative territory, while more than 14 have shown gains in excess of 40 per cent (India is sixth overall with a 57 per cent gain).

Even in developed economies, stock indices are at record highs. The MSCI World Index closed on July 22 just 4 per cent of its all time high. All the major stock markets indices, including those in US, UK, France, Germany and Australia, are within only 5 per cent of their record highs. Japan, while unable to reach the lofty heights at the beginning of the decade, is still at a seven-year high?Yet, even as recovery takes place, there are causes for worry. There is trouble in the emerging world as Argentina's debt worriescontinue and the rise of devaluation in China remains. A Fed rate hike could bust many booms. Investor confidence in emerging markets is still brittle, and a tight liquidity scenario could cause another round of financial crisis in Asia or Latin America. India has participated in the recovery in emerging markets and specifically in the Asian region, even though the crisis largely left it by. It is at the forefront in the race for foreign funds, and a whopping US$1.2 billion has already flowed in 1999. While local shares are less sensitive to international interest-rate movements, a withdrawal of FII funds arising from emerging market worries would hit the markets hard. Last year, we saw local bonds hit significantly and yields widen even though the economy was relatively unaffected. Even if nothing happens on the international front, there will be pressures within the economy. The current rally has been from a very level of undervalued equities. Further increases will need to be based on actual improvementsin fundamentals.

This requires political stability and a will to push through the tough structural reforms required. Finance minister Yashwant Sinha has committed himself to the vagaries of the stock markets as a parameter to judge his performance, and will need to tread carefully. A low-interest-rate environment seems to continue in the near future. Markets are manic-depressive, when they are up, nothing is too high, even 5500 or 6000. On the other hand there were no buyers at 3000 just nine months back and people waited for 2800, even 2400.

The trend for now is up. Perhaps it reflects a structural shift, a new period of long-term growth for the economy and the new base level is indeed 4500. What do I feel? At least 5000, is another view possible? After all as Keynes pointed out, "There is nothing so dangerous as the pursuit of a rational-investment policy in an irrational world."

(The author is the head of treasury marketing in a leading foreign bank. The views expressed in the article are hisown.)