On Friday, November 1, the benchmark stock index, the Sensex, scaled a new high in early- morning trade, bettering its previous record set in January 2008. At one level — admittedly a superficial one — the record-breaking performance of the index is to be seen as a spectacular recovery for the country’s equity market after the economic crisis impacted adversely on corporate balance sheets, leading to a steep fall in their earnings. By the middle of the year the rupee had started declining rapidly, investor confidence was ebbing, and leading brokerages were threatening to downgrade India’s stock markets. Since then confidence might have returned to the markets, but it is by no means clear whether the rally in stocks has any deeper significance than what is apparent. After all, the largely liquidity fuelled rally cannot last indefinitely, dependent as it is on large and sustained buying by foreign institutional investors and portfolio managers. The decision by the U.S. Federal Reserve to continue with its ultra-soft monetary policy has certainly helped for now. A mere hint of winding down the stimulus in May caused a massive flight of dollars back to the U.S. from emerging markets including India. The rally has puffed up the valuations of some shares, but a larger number have lagged behind. Skewed stock indices do not give a correct picture of the stock markets, leave alone the broader economy.

There are other aberrations. Shares of medium-sized companies have not participated in the rally so far. Retail investors who are the backbone of stock markets continue to stay away. Other spin-off benefits from a rising market have not materialised. The government is unable to push through with its disinvestment programme. There is no logical reason why certain sectoral stocks should rise so spectacularly. Bank stocks, especially of public sector banks, have risen, brushing aside the serious problems they face, such as a high level of non-performing assets (NPAs). Finally, the disconnect between the financial sector and the real economy has been spectacularly demonstrated and growth remains subdued. The government optimistically hopes for a growth rate of around 5.5 per cent this year, which will be a dramatic improvement over the 4.4 per cent in the first quarter. There has been some good news recently. As the Finance Minister has emphasised, the current account deficit has become eminently manageable, agriculture is in for a revival as monsoons may be favourable, and there is some hope that the industrial sector will turn around. Welcome as these signs are, they do not indicate an imminent revival to old levels, and certainly do not justify the massive stock market valuations.

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