All that glitters in India’s market isn’t golden: Mihir Sharma

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Published: September 22, 2017 11:52:57 AM

The Indian stock market seems unstoppable. Its major indices have risen over 20 percent this year, making it one of Asia's best performers.

In the past, tax-exempt highway bonds have been attractive to Indian savers. (Image: Reuters)

The Indian stock market seems unstoppable. Its major indices have risen over 20 percent this year, making it one of Asia’s best performers. Indian investors have piled into more than $7.2 billion worth of stock in 2017 and foreigners have bought almost $7 billion.

Yet corporate earnings have hardly recovered enough to justify such exuberance. The quarter between April and June was bad even for some of India’s most blue-chip companies, and smaller firms are hurting even more. By some estimates, India is the most expensive stock market in the world when prices are compared with earnings estimates going forward; the benchmark Nifty index is trading at a forward valuation of well over 20, compared to an average in the past five years of around 16.

So what’s going on? At least some foreign investors have decided that Indian stock prices have run far ahead of fundamentals; they’ve begun to shed some of their India holdings in the last couple of months. But Indian investors have happily taken up the slack — even though it’s hard to find anyone reasonable in Delhi or Mumbai who claims that earnings will recover anytime soon.

And this domestic interest in stocks appears broad-based. A few years ago, Indian mutual funds were declared near death. Now they are having a great year — with much of the impetus coming not from larger cities but from India’s smaller towns, many of which are largely virgin territory for actively managed mutual funds.

The most optimistic view of the situation is that India is finally making the shift towards financial instead of physical savings. Indians have traditionally preferred to invest in tangible assets like property or jewelry. But last financial year, most unusually, total financial savings of households were higher, as a proportion of India’s gross domestic product, than physical savings. A stalling and overvalued housing market may be driving some of the shift. The government’s overnight withdrawal of 86 percent of India’s currency last year may also have increased the appeal of digital transactions.

While this seems like good news — Indian policymakers have long wondered how to get Indians to trust their savings to financial markets — there’s a worrying corollary. If ordinary Indian households that have never thought about stocks before are so starved for access to financial instruments that they’re forced to buy into an overvalued market, the country is setting itself up for a sharp correction that may have much wider repercussions than anything it’s had to deal with so far.

This is something that leaders should be thinking about carefully. The Indian government is, like most governments, always willing to advertise its successes, and it has billed the stock market’s performance as one of them. In fact, it’s a sign of failure: The government simply hasn’t been able to broaden access to other more preferable forms of finance — forms that are either safer or more accessible. Microfinance institutions were decimated by “demonetization,” as the cash ban was called. India’s state-owned bank sector has notably failed to provide remunerative rates for savers, its attention fixed on dealing with a slow-moving bad loans crisis. The government’s social security schemes are poorly designed and their tax treatment makes them unattractive.

Meanwhile, the government itself is running out of money. It’s already blown through over 90 percent of its fiscal deficit for the year. Uncertain about the fiscal implications of its big new indirect tax regime, it has no clear idea where its money in the next quarters will come from — and that means that its ambitious infrastructure plans are less likely to come to fruition.

Isn’t there something deeply wrong with this big picture? India is awash with savings and its households desperately want somewhere safe and lucrative to put that money. Its government wants to invest in infrastructure but doesn’t have the tax receipts to pay for it.

What India needs is a pipeline from its household savings to the infrastructure that it needs to build. In the past, tax-exempt highway bonds have been attractive to Indian savers. The government needs to push for more such instruments — and bend some of its considerable persuasive power to getting people to invest in them. That would be good news all round — except, perhaps, to those betting on the Indian stock market to keep powering ahead for the foreseeable future.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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