A frenzy that leaves fears

A frenzy that leaves fears

After 32 months of ups and downs, India’s stock market roller coaster is back to its January 2008 heights. The Sensex hit the 20,000 mark on Tuesday, ending above that level on Friday. Finance minister Pranab Mukherjee is “happy" about attaining this mark, but policymakers should actually be concerned about the nature of the market rally.

It’s clear that foreign inflows are behind it. Foreign institutional investors (FIIs) have bought 18,000 crore of equities more than they have sold this month, while domestic ones have sold a net 8,600 crore.

Like in 2007-08, it’s global liquidity—and not local conditions—that’s lifting stock valuations so far from fundamentals. The price-earnings (P-E) multiple for the Sensex and the Nifty hasn’t gotten to 2007 levels, but it’s rising fast enough to trigger worries about “bubbles": Between Tuesday and Friday, the Nifty P-E went from 23 to 25

The 2007-08 comparison is instructive here, not only because excessive froth in the market presaged overheating in India’s economy then, but also because regulators had started asking probing questions about these inflows. Then chairman of the Securities and Exchange Board of India (Sebi) M. Damodaran thought that some kinds of foreign money were less innocuous than others: Hence his efforts to ban participatory notes, offshore instruments that highly leveraged hedge funds could hide behind and still use to drive up the Sensex. So what kind of foreign money is involved this time?

The word on Dalal Street is that it’s exchange-traded funds (ETFs), which follow specific indices of stocks. Given the rally has lifted key scrips—say, those on the Sensex—leaving the rest of the market behind, this money is suspect. ETFs make up 17% of FII flows over the last year, Credit Suisse data show.

Or it could be hedge funds. This newspaper’s Mark to Market column noted this month that hedge fund leverage is going up. Sebi did say in March that participatory notes usage had dropped, but it should keep demanding extensive information from participants here.

The idea isn’t for regulators to hurriedly react to such speculative inflows at this point. But the greater the transparency, the greater their wherewithal to stay vigilant, and take action later.

Besides monitoring micro conditions, policymakers shouldn’t make it harder to manage inflows: Last week’s move to increase the FII cap in local debt, at a time of gushing liquidity, only widens the floodgates. Regulators have to realize that the macro situation isn’t conducive.

The real culprits, after all, are Western central banks. The cash they’re pumping in could overheat emerging markets. With the US Federal Reserve last week suggesting it may add even more liquidity, this roller coaster could keep rising—until it suddenly falls.

Is there one fundamental cause behind the rally? Tell us at views@livemint.com