The Bombay Stock Exchange
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This divine combination – of capital inflows into India alongside low Indian interest rates – cannot sustain indefinitely.

The sequence of events which has transpired in India over the past couple of years is reminiscent of what happened in America in the decade running up to the Lehman crisis when the US markets believed that there was a Greenspan put in play; i.e. whenever it looked as if the US markets were facing a challenge (e.g. the LTCM crisis in 1998, the aftermath of 9/11), Greenspan would come to the rescue with monetary easing. These interventions by the Fed emboldened investors to take increasingly risky long bets in the US stock and bond markets until that party ended in 2008. So is India heading down the same road? In specific, can Mr Modi underwrite returns for equity investors?    

The illusion that the Indian government holds the country’s destiny entirely in its own hands has been facilitated by a combination of circumstances. Some of these circumstances, to the NDA government’s credit, are of its own making; e.g. fiscal rectitude in all of the budgets that this government has presented so far and an attack on black money.

The Sensex’s 12 month trailing P/E is nearly approximately 2 standard deviations above the mean | Source: Bloomberg, Ambit Capital research

However, India has also benefited enormously from benign oil prices alongside the liquidity generated by Western central banks. This has allowed us Indians to have our cake (in the form of consistent inflows of foreign capital in our financial system) and eat it too (in the form of low CPI inflation and low interest rates). This divine combination – of capital inflows into India alongside low Indian interest rates – cannot sustain indefinitely.

As the Western economies recover, not only are commodity prices likely to rise globally but also foreign capital inflows into India could slow down. Alongside this, if the NDA were to let its fiscal rectitude slip in a bid to win more elections over the next 17 months, then the outlook for the market could change very quickly.

Saurabh Mukherjea is the CEO of Ambit Capital Pvt. Ltd.

This analysis originally appears in ‘The Sceptical CEO’ section of the Ambit website. This post is an excerpt from the analysis ‘Is there a Modi put option?

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