Liquidity-driven Euphoria Ebbing

THE LAST ONE YEAR has been unprecedented bafflement for equity investors. The pandemic caused a big economic shock which was also characterized by the quickest and largest rebound inequities.

- DHANANJAY SINHA

In little over one year, India’s benchmark equity indices doubled, and are 32% higher than the pre-pandemic peaks in January 2020. The mid-and small-cap indices surged even more dramatically, rising by 140% and 170% from their respective lows. The characterization of global markets is broadly the same. In the rebound from the lows, India has been among the top-performing markets.

But have a business and the economy rebounded in any proportion similar to the market? What explains the resurgence and will it sustain?

Based on the somewhat optimistic official projections of 9.5% real GDP growth in FY22E, followed by 7.5% in FY23E, the compounded growth over the FY19 level would be just 1.8% and 2.9%, respectively. So clearly market capitalization for equity markets has compounded exponentially relative to GDP. If the post-GFC 2008 era was a liquidity-driven surge, accompanied by feeble growth, the last one year has been superlative.

U.S. money supply to GDP has risen dramatically from sub-70% to over 90% in the aftermath of the massive expansion in the U.S. Federal Reserve balance sheet by $4.1 trillion to $8.1 trillion during January 2020-June 2021. Expectedly, India saw its forex reserves rising by over $130 billion to $609 billion, with foreign portfolio flow adding $36 billion. With domestic credit demand remaining low and large Indian companies deleveraging, the liquidity in the banking system has bulged significantly to 3% of total bank deposits. Thus, this combination of poor growth and liquidity deluge has resulted in valuation bubbles all across.