Indian stock markets are continuously breaking and making fresh record highs day after day since the beginning of 2018. Earlier on Tuesday last week, Indian equities broke into all-new levels with the headlines indices Sensex and Nifty breaching their respective psychological marks of 36,000 and 11,000. Nifty had extended the gains very quickly surpassing the 11,000-mark for the first time ever on Tuesday. The 30-share barometer Sensex also surged heavily to breach the level of 36,000, and that too just after three sessions when the key index crossed 35,000-mark.
Broadly, Indian equities are on a perpetual upsurge for the last 13 months with Sensex and Nifty rising about 39%. Meanwhile, in the same period, shares of blue-chip companies such as Indiabulls Housing Finance, Titan, HDFC Bank, HDFC, Reliance Industries, Bharti Airtel, DLF, Tata Steel, Maruti Suzuki, IndusInd Bank, Vedanta and HUL. Following the record-breaking run in India’s stock market, Sensex and Nifty have managed a year to date return of 6-8%. With such an unprecedented rally in the domestic stock markets, we take a look at key things which were highlighted in Economic Survey 2018.
This image shows the foreign investment in India since the beginning of the financial year 2013-2014.
Normally, when stock prices boom, as they have done in the past two years, firms issue more equity publicly, taking advantage of the reduced cost of capital to embark on new investment projects. This happened in the mid-2000s and again around 2010. In the last two years, especially in the first eight months of this year, there has once again been a pick-up in equity-raising activity. If current trends continue, the number of issues and their value could double the levels recorded in the previous six years
How do these magnitudes compare with the previous periods of stock market euphoria? Figure 1 illustrates total capital raised—through public and private placements—over the last decade as a percent of GDP to make the temporal comparison accurate. The red line depicts the price-earnings ratio. The green bars show that capital raising this year has picked up substantially but remains below levels reached in 2007-08, the peak of the previous boom despite the fact that the cost of capital is at similarly low levels: a price-earnings ratio of 25 implies equity costs of roughly 4 percent
Critically, real interest rates have diverged substantially. Rates in the US have persisted at negative levels, while those in India have risen to historically high levels. Over the period of the boom, US real rates have averaged -1.0 percent, compared to India’s 2.2 percent, a difference of 3.2 percentage points (Figure 5).
Bond yields have increased sharply since August 2017, reflecting a variety of factors, including concerns that the fiscal deficit might be greater-than-budgeted, expectations of higher inflation, a rebound in activity that would narrow the output gap, and expectations of rate increases in the US.
Over the past two fiscal years, the Indian stock market has soared, outperforming many other major markets. As Figure 1 shows, since end-December 2015, the S&P index has surged 45 percent, while the Sensex has surged 46 percent in rupee terms and 52 percent in dollar terms. This has led to a convergence in the price-earnings ratios of the Indian stock market to that of the US at a lofty level of about 26 (Figure 2). Yet over this period the Indian and US economies have been following different paths. So what explains the sudden convergence in stock markets?
The stock market surge in India has coincided with a deceleration in economic growth, whereas US growth has accelerated (Figure 3). India’s current corporate earnings/GDP ratio has been sliding since the Global Financial Crisis, falling to just 3½ percent, while profits in the US have remained a healthy 9 percent of GDP (Figure 4). Moreover, the recently legislated tax cuts in the US are likely to increase post-tax earnings.
The price of an asset is not solely determined by the expected return on that asset. It is also determined by the returns available on other assets. As pointed out in last year’s Economic Survey, the government’s campaign against illicit wealth over the past few years—exemplified by demonetisation—has in effect imposed a tax on certain activities, specifically the holding of cash, property, or gold. Cash transactions have been regulated; reporting requirements for the acquisition of gold and property have been stiffened. In addition, rupee returns to holding gold have plunged since mid-2016, turning negative since mid-2017 (Figure 7).
In addition, previously, stock prices had suffered because reporting requirements were higher on shares than purchases of other assets. But the attack on illicit wealth has helped to level the playing field.
All of this has 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 (Figure 8). Accordingly, the equity risk premium (ERP, the extra return required on shares compared with other assets) has fallen.
This image shows the contrast between trend between government securities and BSE Sensex from 19 May 2015 to 19 January 2018.