Economic Survey 2018: Stock price corrections could also trigger capital outflows, especially if monetary policy unwinds less hesitantly in advanced countries and if oil prices remain high. Policy might then have to respond with higher interest rates, which could choke off the nascent recovery.
Economic Survey 2018: With Indian stock markets hitting record highs, the Economic Survey for 2017-18 said policy vigilance will be necessary in FY18, especially if elevated stock prices correct sharply, provoking a “sudden stall” in capital flows. The BSE Sensex rose 233 points to touch a fresh lifetime high of 36,283.25 on Monday, while the Nifty finished at record 11,130.40. “Savers, already smarting from reduced opportunities in the wake of demonetization, from depressed gold prices, and from lower nominal interest rates, would feel aggrieved, leading to calls for action,” the Survey noted. Stock price corrections could also trigger capital outflows, especially if monetary policy unwinds less hesitantly in advanced countries and if oil prices remain high. Policy might then have to respond with higher interest rates, which could choke off the nascent recovery.
“The classic emerging market dilemma of reconciling the trade-off between macro-stability and growth could then play itself out,” it added. Comparing with a similar trend in US markets, the economists of finance ministry noted that the US private corporate sector is stashed with cash because of high profits and weak investment opportunities. But this is not the case in India, as firms face significant capital needs, arising from low levels of profit and cash, and high leverage (debt-to-equity) ratios, they said. It’s possible that the portfolio shift by Indian investors in favour of shares set in train by the campaign against illicit wealth will result in a sustained reduction in the equity risk premium (ERP), they noted.
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But, it is worth recalling that a similar assessment was made in the US after its ERP fell sharply in the late 1990s-early 2000s. A few years later, the technology bubble collapsed, then the Global Financial Crisis occurred. Beyond ERPs, sustaining current stock valuations in India also requires future earnings performance to rise to meet still-high expectations.