Mumbai: As India’s benchmark index, the Sensex, trades at just 7.5% shy of its lifetime high, the market capitalization of all listed stocks in the country is equivalent to 104% of the country’s gross domestic product (GDP).

This ratio is well short of its all-time high of 160%, leading some analysts and fund managers to suggest that there is still some steam left in the current market rally.

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On Friday, the Sensex closed at 19,594.7 having gained 9% since the beginning of this month. Now, it is trading some 1,483 points short of its all-time high of 21,078 touched on 8 January 2008.

Then, the market capitalization touched Rs74.5 trillion and accounted for 160% of that year’s economic output, according to Bloomberg data. At Friday’s close, India’s market cap stood at Rs70.5 trillion. Assuming 8.5% GDP growth for this fiscal and average inflation of 7.5%, Mint calculated the current market capitalization to GDP ratio at 104%. Even if fiscal 2010’s GDP is taken for this calculation, the metric stands at 120%, short of the previous high.

Some market experts note that the valuation of Indian companies has lagged the pace of economic growth and say this offers scope for further appreciation. Conversely, it also suggests that further growth in stock prices will depend on economic, and thereby, company earnings growth.

“Basically this means that GDP growth has been much faster," said Andrew Holland, head of equities at Ambit Capital Pvt. Ltd. “If one believes in the 8%-plus India growth story, then at some point, corporate earnings growth close to 30% has to kick in."

After the financial crisis of 2008, company earnings have bounced back to double-digit growth. Despite a mixed bag of earnings in the first quarter of this fiscal, the consensus estimate for listed firms’ profit growth is still 20% for fiscal 2011.

To be sure, Indian equities are not exactly cheap. The 50-stock Nifty index of the National Stock Exchange is trading at a multiple of nearly 19 times its estimated earnings for 2011, higher than its historical average of around 15.

Still, the price-earnings multiple of all the stocks in this index is below the highs they reached in the previous bull market rally. This holds true for even stocks such as State Bank of India and ICICI Bank Ltd—to name just two—which have powered the rally in the past month.

Nonetheless, as investors seek more growth opportunities in equities, given the low interest rates especially in developed market fixed-income securities, local stocks have found favour with foreign institutional investors, or FIIs. This category has invested $15.6 billion (Rs71,760 crore) in Indian equities in 2010, as they pumped money into emerging markets.

Not only that, fund managers also say that Indian firms are “under-owned", leaving scope for more foreign buying. FIIs hold an average of 12% share in BSE 500 companies, which make up 93% of the market capitalization on the Bombay Stock Exchange.

“From a foreign investor’s perspective, the Indian market does appear very attractive, given the sharp growth in GDP," said Krishna Sanghvi, head of equities at Kotak Mahindra Asset Management Co. Ltd, who helps manage Rs26,595 crore worth of assets.

“While the US economy is expected to grow at a nominal rate of 3-4%, the Indian economy will grow by all accounts at more than 14% (in 2010) and international investors are becoming aware of this difference," he added.

Not everyone though is convinced by numbers. After all, following the financial crisis, the market capitalization to GDP metric has declined for all countries. Secondly, a smaller market capitalization to GDP ratio could indicate that there is a large unorganized sector and need not necessarily mean that the stock market in that economy is under-valued.

A section of market participants also holds that the India growth story has already been priced in by the markets. They suggest that the rally is being powered by a wave of liquidity which has driven up stock prices around the world.

“Nothing fundamental has changed between July and there has been no new trigger for the markets to go up with the earnings season being mostly a disappointment," said the head of research at a local bank-owned brokerage, who didn’t want to be identified as he isn’t authorized to speak to the media.

However, better risk appetite among investors in developed markets has led to the liquidity surge and the lack of strong returns in those markets means that most fund managers believe the party will go on for some more time.

Graphic by Paras Jain/Mint

Ashwin Ramarathinam contributed to this story.