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Are the levels sustainable?

The stock markets, after consolidating their gains made early in the week, closed at record levels on Friday. The benchmark stock indices, the Sensex and the Nifty ended higher by 6.4 per cent and 7.3 per cent respectively over their levels at the start of this week. However welcome the rising market valuations are, questions need to be asked whether the heady run of this week is sustainable even over the short-term. The 653-point rise in the Sensex on Wednesday taking it past the 16,000 mark has been the highest gain ever during any trading day. The buoyancy in stock prices is attributed to the action of the U.S. Federal Reserve in effecting a larger-than-anticipated cut in interest rate a day earlier. While the rate cut and the flow of funds from foreign institutional investors could well have triggered the upsurge in stock prices across Asia and practically everywhere else, it is too early to assess its full implications even for the U.S. economy, leave alone for countries such as India. For Asian countries including India, the U.S. is the most important trading partner. Still, it is highly unlikely that the prospect of lower interest rates in the U.S. can so comprehensively boost the sentiment in stock markets. For India, the positive factors include a consistently strong economic growth and a stable macroeconomic and regulatory environment. However inflation remains a potent threat and global oil prices are ruling very high.

It would be unwise to draw any broad lessons from recent stock market exuberance. Most importantly, stock prices by themselves, even if they are less volatile than in the past, do not signal higher economic growth. Some of the top Indian stocks were overvalued even before the current spurt. A correction, as and when it takes place, might cause a sharp fall in the indices. One can only hope that Indian retail investors too will benefit this time. As in the case of the surging rupee that touched a nine-year high and is quoting well below Rs.40 a dollar, there is always a flip side to seemingly favourable economic news. An appreciating rupee affects export competitiveness and lowers the profit margins of software companies and other service exporters. There are limits to any intervention by the Reserve Bank to shore the dollar up against the rupee. In any case, the two-stage process of first mopping up dollars and thereafter sterilising the rupees by issuing bonds has several hidden costs and cannot be pursued indefinitely. For the capital market, the biggest worry ought to be that despite an impressive record of reform, foreign players and influences seem to be the determining factors.

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