PRINT THIS PAGE The Indian Stock Market – Continued Boom or Impending Bust?06/02/2008. Source: Evalueserve.
During 2005, India’s economy grew by 9% and reached US$ 800 billion, and during 2006, it grew by another 9.2% to reach US$ 910 billion (in nominal terms). At the same time, during the last 16 years, i.e., 1991–2006, annual inflation—as measured by the average Wholesale Price Index (WPI)—has been approximately 6.7%, and given the savings rate and liquidity in the system, our analysis shows that the annual inflation in the country will likely to hover around 5% during the next 14 years (i.e., until 2020). So, assuming a constant exchange rate where one US Dollar equals 40 Indian Rupees,1 India’s economy is likely to be US$ 1,030 billion in 2007, US$ 1,490 billion in 2010, and around US$ 5,040 billion in 2020 (all in nominal terms). This implies that including inflation, there will be approximately a five-fold increase in India’s economy between 2007 and 2020. “But how do we know when irrational exuberance has unduly escalated asset values, which then becomes subject to unexpected and prolonged contractions as they have in Japan over the past decade?“
– Alan Greenspan (Dec 1996)
During the last 42 months, the Indian stock market, as represented by two major indices—Sensex (Sensitive Index) and BSE-100, has grown by approximately 290%. This corresponds to a cumulative annual growth rate of 36%. The Indian market is somewhat unique in the sense that the country’s economy has been growing at a rate of over 8–9% per year in real terms and at 14–15% in nominal terms. Many investors believe the rising valuations of stocks in India are justified because “this time, it is different”. Of course, everyone has heard this phrase before, but we wonder whether things are really different this time around, or whether investors are setting themselves up for another major correction in the prices of various assets. In our opinion, since India has a large budget deficit (a large part of which supports unproductive subsidies and salaries of government employees) and a large current account deficit, Indian markets may be quite vulnerable to a sudden flight of capital and a potential downturn in the market. On one hand, there is enormous liquidity in the global market and this liquidity is likely to continue growing (at least in the near future). On the other hand, the enormous inflow of foreign currency in the Indian stock market, particularly by foreign institutional investors (FIIs), seems to be a cause for worry as this money is also susceptible to a quick flight out of India. Moreover, this inflow has appreciated the Indian Rupee substantially and has begun to hurt both Indian exports and the domestic industry.
Given this backdrop, in this article, we investigate whether the recent, sharp growth of the Indian stock market is justifiable or whether it is also a case of “irrational exuberance.” Indeed, if it is the latter, then the impact of its downfall will be felt not only in India, but also worldwide. We also discuss several scenarios and highlight some silver linings that may keep the Indian economy in a good growth mode.
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