ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846
-A A +A

Stock Boom and the Macroeconomy

   Stock Boom and the Macroeconomy The current stock market boom, which has seen the Sensex sweep past the 8000 mark, is remarkable for the unease that it has created among at least the Indian players in the market. While there is no dearth of pronouncements about the Indian economic miracle, many in the financial community have been indicating that a significant correction could be due and urging caution on small investors. This reflects the perception that valuations are truly stretched at present levels. A forward multiple for 2005-06 of 15-16 for the Sensex translates into a yield of around 6 per cent, which implies little or no premium over the risk free rate. It is disingenuous to suggest that a multiple of this order is somehow more sustainable than the multiples of over 25 in the booms of the past. When foreign institutional investors (FIIs) enter a market with a limited number of liquid stocks, multiples tend to soar into the stratosphere. Funds keep flowing in, nevertheless, as FIIs think it necessary to gain exposure to the market in order to understand it better. Such is not the case now in India. FIIs have been around for more than a decade and the supply of stocks as well as trading volumes are much larger than in the past. It is fatuous, therefore, to attempt to justify the present market level in terms of economic fundamentals. It is more sensible to accept that the boom is liquiditydriven and hence vulnerable to any drying up of such liquidity consequent to developments in international markets. When such a reversal will take place is impossible to predict. The world is awash in liquidity, the result largely of the benign policies pursued by the US Federal Reserve ever since the technology bubble burst in that economy in 2000. All assets in all markets have been rising and the Indian stock market is but part of this worldwide phenomenon. The challenge for policymakers, rather, is to ensure that any reversal in the present trend, which would cause stock prices to fall, does not impose major costs on the economy. For markets where fundamentals are sound, the reassuring thought is that a large net outflow of funds is not very probable. The behaviour of institutional investors in the past indicates that this happens rarely. A net outflow would cause stock prices to plummet sharply and it would also cause the currency to depreciate. Institutional investors would take a huge beating and hence would exit only when they judge that the losses if they stayed invested in the market would be even greater. It is more likely that net inflows into the market would decline. As market prices would have climbed on expectation of continued inflows, a net decline would indeed cause prices to fall but this would fall short of a crash of the sort occasioned by net outflows. In dealing with a stock market decline, India is better placed than many economies. First, the improvements in governance of the stock exchanges give us reason to believe that a decline will not translate into a crash on account of bankruptcies among market participants. Second, thanks to stringent regulations, banks

Subscribers please login to access full text of the article.

New 3 Month Subscription
to Digital Archives at

826for India

$50for overseas users

Get instant access to the complete EPW archives

Subscribe now

Comments

(-) Hide

EPW looks forward to your comments. Please note that comments are moderated as per our comments policy. They may take some time to appear. A comment, if suitable, may be selected for publication in the Letters pages of EPW.

Back to Top