Mumbai: Indians pouring record amounts of their savings into a stock-market rally risk getting burned.

Earnings per share at companies in the NSE Nifty 50 Index have stagnated since the run up to the 2014 elections, which triggered a surge in equity prices. The index has risen 50% over the same period. Bridging the gap won’t be easy after already-slowing economic growth was slugged by Prime Minister Narendra Modi’s demonetisation drive late last year and the disruptive roll out of a goods and services tax this July.

The cash ban funnelled savings into banks, forcing them to lower deposit rates given the slow pace of corporate lending. Savers looking for higher returns piled into equity markets, strengthening what was already a consistent flow of domestic money into stocks.

“There is a lot of frothiness in the market," Prateek Pant, co-founder of Sanctum Wealth Management, which has $770 million in assets, said last week. Most of the local money is flowing into balanced funds but “unfortunately, these products are sold as an alternative to fixed deposits, which is incorrect. Earlier, people have burnt their hands in the process and now they could be burned again."

A correction in equities would hit closer to home this time because an unprecedented number of Indians would see their wealth erode, unlike previous instances where global funds bore the brunt. While the overall share of stocks and bonds in national income is still relatively low, Modi wouldn’t want sentiment to sour with elections a little more than a year away.

Michael Patra, an executive director with India’s central bank, has said monetary policy must consider bubbly market valuations. A spokesman for market regulator Securities and Exchange Board of India didn’t respond to a call and email seeking comment sent Thursday.

Valentine’s Day

Equity mutual funds added almost 5 million investor accounts in the six months ended 30 September, an all-time high. The 80, 400 crore ($12.4 billion) of net inflows during the period are more than triple the amount seen during the same stretch last year.

Mutual funds are seeing flows of about Rs50,000crore , or about 7% of annual financial savings, into so-called systematic investment plans, which allow a pre-agreed amount to be invested at regular intervals, said Nilesh Shah, chief executive officer at Kotak Mahindra Asset Management Co. That can reach 20%, he said, without specifying a time frame.

“We have grown our SIP books 10 times in the last three years with a ‘SIP Day’ kind of celebration," Shah said. “SIP Day is our Valentine’s Day."

India has “successfully institutionalized equity savings" as illustrated by continued domestic inflows despite disruptions such as demonetisation and the sales tax roll-out, Ridham Desai, managing director at Morgan Stanley India Co., said last month.

Some analysts are sanguine about the risk of a correction. Earnings for the three months ended September will increase 10% from a year ago, according to forecasts from CLSA India Pvt. for the 104 companies it tracks, a turnaround from the 18% decline of the previous three months. Citigroup Global Markets India Pvt. expects profits for the 131 companies it covers to increase 13%.

“One year lost due to demonetization and GST, but the recovery is coming," said Ajay Bagga, executive chairman at OPC Asset Solutions Ltd. “The skepticism about the markets makes them stronger. The government has goofed up but the inner dynamics of the Indian economy and psyche will see us rebounding."

Too optimistic?

The risk is that projections have been too optimistic. Earnings at NSE Nifty 50 Index constituents have trailed consensus forecasts for most of this decade, data compiled by Bloomberg show.

The same trend is witnessed with economists, who have been lowering India’s growth forecasts. For instance, back in October 2016—a month before Modi invalidated 86% of currency in circulation—economists expected gross domestic product to grow 7.7% in the July-through-September period. The estimate is now at 6.6% after five reductions.

Financial savings are also increasing at a time when India’s overall savings rate is falling, which means that any drop in stock or bond prices will leave the government with even less money to allocate. The International Monetary Fund predicts the savings rate will decline to less than 28% of GDP by 2022 from 28.5% now and 33.5% in 2012.

If sentiment sours on the economy or market valuations, a correction will drag down real growth, said Radhika Rao, an economist at DBS Bank Ltd. in Singapore. Sanctum’s Pant says a sell-off may come as early as November, after the traditional festive trading this month.

“Markets are heating like a tinderbox, complacency is at the highest level you will see," said Sanjiv Bhasin, executive vice president at Mumbai-based brokerage India Infoline Ltd. “This is the time to start smelling the coffee." Bloomberg

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