Irrational Exuberance in India’s Equity Market: Dr. Barendra Kumar Bhoi,former Principal Advisor and Head of the Monetary Policy Department of RBI


Both BSE Sensex and NSE Nifty are currently hovering at all-time high levels. India’s equity market parameters suggest irrational exuberance with market-capitalization-to-GDP (MCG) ratio exceeding 100% as against an average of 75% during the last decade. The MCG ratio above 100% was last witnessed in 2007-08 when India’s real GDP growth was 9.3%. The stock-price boom this time is ironically coincided with the contraction of real GDP by 7.3% in FY21 – the highest de-growth since India’s independence. The average NSE Nifty price-earnings multiple, which was at a historic high of over 40 in March 2021, softened to around 30 by mid-June 2021, compared to the median PE multiple of about 20 since 1999. The price-to-book value ratio in June has been ruling around 4.5 compared to the median value of around 3.5 during the last two decades. The RBI has repeatedly expressed concern about overvaluation of Indian equities compared to the fundamentals.

Besides the traditional players like Foreign Institutional Investors (FIIs), Domestic Institutional Investors, particularly Mutual Funds (MFs), there is a proliferation of retail investors, who have directly entered into the India stock market during last one and half years due to decline in returns on alternative financial assets, particularly bank deposits. There are mainly two reasons why investors are so bullish about the Indian stock market. In the short-run, boom in equity prices is fueled by historically low money market rates following both RBI and major central banks injecting unprecedented liquidity to protect their economies from ravages of the Covid-19 pandemic. In the medium-term, investors – both domestic and foreign – are hopeful that the Indian economy would bounce back quickly to its trend rate of growth (around 7.5%) as India’s medium-term fundamentals are sound. For the time being, both short-term excess liquidity and medium-term outlook complement each other pushing the equity prices to unsustainable levels in India and abroad.

While global short-term interest rates have already started rising, a turn-around in the domestic rate cycle is imminent. The RBI’s low policy-rate cycle seems to have reached a dead end. Notwithstanding weak aggregate demand, inflationary pressures have built up in the economy for several reasons. Notable among them are: a) rising international commodity prices, especially crude oil prices, b) high central excise duty/state taxes on diesel and petrol, c) rising logistic costs due to Covid second wave, and d) high core inflation following rising input cost pressures. The RBI’s Monetary Policy Committee (MPC) would find it difficult to pursue an ultra-accommodative monetary policy for a longer period.  Similar to the taper tantrum in 2013, stock prices globally are waiting for a trigger for correction as soon as major central banks start tapering their bond-buying programme. Indian market is not immune to such an eventuality.

Since early 2020, the RBI has been firing from all barrels to flood the financial market with excess liquidity leading to short-term rates often crashing below the reverse repo rate. From February 2020 to end-March 2021, the RBI announced ₹13.6 trillion liquidity injection of which ₹8.9 trillion was absorbed by the economy. During FY22 so far, liquidity provision made, including purchases of the dollar, amounts to ₹6.5 trillion, of which about ₹4 trillion have been used.

Going forward, the RBI cannot afford the luxury of buying both domestic and foreign securities together. The choice between the two is limited as the RBI is committed to managing the central Government’s huge borrowings of about ₹13.6 trillion at the lowest possible cost for the second year in succession. Domestic bond-buying under G-Sec Acquisition Programme (G-SAP 1&2 so far) would be constrained from Q3 as the CPI inflation has already exceeded 6% in May 2021.

The medium-term outlook offers a mixed bag with high downside risks for India returning to the trend rate of growth. A normal monsoon, rapid immunization against Covid-19, and implementation of several structural reforms provide hope for a steady recovery of the economy. However, the Indian economy recovering to the trend growth rate of 7.5% from FY23 is most unlikely unless structural problems preexisting before the Covid-19 pandemic are resolved. Notable among them are: a) declining trend in gross fixed capital formation (GFCF) as a proportion to GDP, b) enduring NPA problem in banks and NBFCs, c) weakness in corporate balance sheets, and d) slowdown in total factor productivity.

Despite the make-in-India initiative, encouragement to startups, incentives for affordable housing, large capital expenditure by the government, etc., the GFCF has declined from 33.3% of GDP at current prices in FY13 to 27.1% in FY21. The economy growing at 7.5% from FY23 requires the GFCF to rise significantly above the current level. Despite considerable damage done by the second wave of Covid-19 pandemic to the economy, India’s growth numbers in FY22 would look impressive due to an exceptionally low base effect.  Even if India grows at 8.3% in FY22, as predicted by the World Bank in May 2021, India’s real GDP would remain around the level achieved in FY20. Incidentally, India’s real GDP growth in FY20 at 4% was one of the lowest in recent years.

Recent normalization of implied volatility and announcement of dividend by some corporates in Q4FY21 give a false sense of exuberance. The investors are currently euphoric about banking stocks under the assumption that setting up of the National Asset Reconstruction Company (NARC) would resolve the NPA problem permanently. Shifting NPAs from multiple balance sheets to NARC is a new experiment being implemented by banks for cleaning their balance sheets. Success of the scheme depends a lot on the improvement of corporate balance sheets. Most of the big industrial houses are currently embroiled in the resolution processes under the Insolvency and Bankruptcy Code. To reduce the burden on NCLT, the pre-pack resolution framework for MSMEs is being implemented. Until corporate sector balance sheets improve, it would be difficult to raise India’s GFCF and thereby accelerate the GDP growth to its trend rate.

India’s high growth story has been significantly contributed by the services sector and MSMEs. Both these sectors were severely hit by the recent pandemic. Rescue operations by the government/RBI may be constrained by availability of policy space. FIIs are always a fair-weather friend. They have already reduced their commitments in the debt market. Strong US dollar, rising US interest rate and likely Fed rate hike sooner than expected are recipes for FIIs to withdraw from Indian equity market. Investors be aware of the stock prices and the policy constraints.  


  1. Your second para is the answer to all the issues you have so meticulously listed.
    RBI’s concern on the disconnect between equity markets and the real economy arises out of its inability to eschew a ‘guided’ interest rate regime forcing you and me to discover ‘alpha’ in equity markets. We cannot ignore the fact that more than ten mio demat accounts have been opened during the last 15 months. Coupled with the floodgates of liquidity opened by RBI and low or near negative interest rate pursued by the FED, both domestic and firangi money are seeking solace in India’s capital markets.
    Age old measuring rods like MCG ratio, PE ratio and PBV ratio are no longer useful as they used to be because of the changing dynamics between demand and supply. Corporates have clocked record profits during the pendency of the pandemic.

    As interest rate elsewhere inches upward, our equity markets may make some correction. But there is no way of going back to the earlier era unless the markets are visited by frauds or severe geo political developments.


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