The stock markets are as much a function of society as of citizens, as much an expression of the collective as of the individual, as much a signature of earnings as of speculations, and as much a paradox as an indicator. So, when you look at the market capitalisation—the combined market value of all listed companies—on the Bombay Stock Exchange (BSE) crossing the US $3 trillion mark for the first time on 24 May 2021, examine all these components while evaluating the event.
BSE CEO Ashish Chauhan captures the statistics: 69 million registered investors, 1,400 brokers, 69,000 mutual fund distributors and 4,700 companies have come together to converge around the INR 219 lakh crore number, he wrote. For context, India’s GDP (gross domestic product, defined as “the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsidies not included in the value of the products”) is estimated to be INR 196 lakh crore. The market capitalisation to GDP ratio, therefore, stands at 112 percent.
Growing steadily over the past 15 years, barring the 2010 jump to 97 percent, India’s market capitalisation to GDP ratio has fluctuated around the 70 percent mark. During this time, both the economy as well as the markets have grown steadily, at their own paces. At 112 percent today, this ratio is the highest ever. Against the world average of 129 percent, this number is lower than the US (222 percent), Canada (180 percent), South Korea (136 percent), Japan (133 percent) and the UK (131 percent). But it is higher than China’s 79 percent.
Of course, all these markets have hit their highs over the past year. At 85 percent, the absolute (not adjusted for currency) 12-month returns from India are the world’s highest, followed by South Korea (81 percent), Canada (63 percent), the US (51 percent), the UK (48 percent) and Germany (46 percent). But you don’t assess or analyse a market based on such short-term movements. Over the past two decades, the market capitalisation of Indian markets has increased at a compounded annual growth rate of 18.2 percent.
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This growth can be seen in several ways. First, the denominator—GDP growth. From the International Monetary Fund (IMF) and the World Bank, to other multilateral institutions and large private brokerages, India is among the fastest-growing (if not the fastest-growing), economies of the world. The IMF April 2021 World Economic Outlook forecasts that India will grow by 12.5 percent in 2021 and 6.9 percent in 2022—the highest among large economies. The Asian Development Bank April 2021 Outlook forecasts India’s growth rates at 11.0 percent in 2021 and 7.0 percent in 2022, again the highest among large economies. If the underlying growth is high, markets will follow. At the moment, the rise in markets is higher than that of the economy; hence, the market capitalisation to GDP ratio has crossed 100.
Second, point to point returns. Over the past 30 years, the Sensex has risen from less than 1,000 to more than 50,000, a CAGR of 14.9 percent. The number is 13.4 percent for the past 20 years, 11.9 percent over the past 10 years, and 14.6 percent over the past five years. These returns are among the highest in markets that have a current capitalisation of more than US $2 trillion. For the past 30, 20, 10 and five years, the returns from the US markets, for instance, are 8.6 percent, 6.1 percent, 11.2 percent, and 14.6 percent. Those from Hong Kong are 7.0 percent, 4.8 percent, 4.0 percent, and 11.7 percent. A liquidity surplus is pushing stock price values higher globally. In India, it is being accentuated by domestic investors that have been investing in equity mutual funds.
Third, with the rise in stock prices and market capitalisations comes a commensurate increase in valuations, leading some analysts to say that the Indian market, like several others, is overvalued. At 31 times, India’s price to earnings multiple is among the highest. A one-time high is not the problem; a sustained high PE multiple could be. But the high PE multiple today is possibly factoring in the past track record of economic growth and the expectations of growth to continue into the future. As a result, the country, and through it, the underlying companies that are growing faster than the economy, gets a premium. This could change overnight, of course.
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And fourth, a large base of consumers and a high scale of industrial and services activity combined with a rising entrepreneurial zeal does wonders. Is Indian business at that take-off point? We cannot be sure—a US $2.7 trillion economy, the world’s fifth largest after the US, China, Japan and Germany, India is expected to be the world’s third-largest economy within this decade. This GDP will ride companies. The Made in China COVID-19 virus notwithstanding, global and Indian investors are seeing that story play out.
The US $3 trillion market capitalisation of Indian companies shows the scale of its institutionalisation with a larger number of direct investors and through intermediaries such as mutual funds, insurance and even provident funds entering it. The paradox, if any, is not the brute force of these investments that have taken valuations higher, but the strengthening of the underlying companies that will catch up with the valuations. The mean reversion, a theory that says markets may fluctuate in the short term but revert to a long-run mean in the long term, will definitely come over the next decade. But this revert, again in the long term, will happen more because earnings of companies will grow rather than their market values fall.
Markets are moody creatures in the short term but consistent deliverers in the long term. And despite a great story, things could go wrong. At every moment in time, they can appear overvalued. They have proved analysts wrong several times over. If you are an Indian investor, you must be invested. But if you are foreigners, remember that with the Sensex at 50,000, India has reached a scale where a 10 percent equity exposure in your portfolios is a necessary growth allocation—not emerging markets, not Asian markets, but Indian markets. Of course, you could wait for it to touch 60,000 or 75,000 or higher before you agree!
Gautam Chikermane @gchikermane is Vice President at ORF. His area of research is international and Indian economic policy. Views are personal.
The article originally appeared on the Observer Research Foundation website.