But the other reason was global nervousness about higher interest rates. This is what a recent article in Bloomberg said: “Strategists say developing markets are showing parallels with May 2004, when the MSCI index recovered from a two-month tumble of 11% to rally 26% by the end of the year. Like then, investors are pulling money out of emerging-market funds on concern lending curbs by China and interest-rate increases from India to Brazil will restrain economic growth."

Consider, for instance, the S&P 500 in the US. This index reached a high of 1,163 in March 2004, fell to a low of 1,076 in May, but it wasn’t before November that it was able to cross its March highs. The Footsie (FTSE 100) reached a high of 4,601 in April, but it was only in September that it could cross that level again. In Asia, the Hang Seng Index reached a high of 14,058 in March 2004, fell to a low of 10,917 in May and was able to surpass its March highs only in November.

Also Read Manas Chakravarty’s earlier columns

Going by this track record, could 2010 also be a washout for the markets? After all, the Sensex ended 2004 at a level that was a mere 5.6% above its January high, although it gained 41.8% the following year. This time around, though, there are several factors that make the current recovery rather different from the one in 2004.

The first thing that comes to mind is valuations. In January 2004, the trailing price-earnings (P-E) multiple for the Sensex was at 19.39—in January 2010 it was at 21.99. Indeed, the trailing P-E for the Sensex on Monday was 19.76. It would be more appropriate, however, to take the one-year forward P-E. In March 2004, that was 12.4 compared with around 14.9 currently. Even after the big drop from the January highs, the market is still pricey compared with the same period in 2004.

But perhaps the markets are putting a higher value on Indian growth, after having seen that the economy is capable of growing at more than 9%? Well, gross domestic product (GDP) growth in 2003-04 was 8.5%, compared with the government’s recent estimate of 7.2% growth for 2009-10. So it’s not as if investors didn’t know what the economy was capable of doing. More importantly, there were several signals in 2004 that high growth would not lead to overheating any time soon.

But first, here’s a remarkable coincidence—in mid-January 2004, the year-on-year growth in bank credit was 14%, while bank credit growth as on 15 January 2010 was 13.9%. That’s where the similarities end, however. The credit-deposit ratio for banks was a very comfortable 55.2% in January 2004, which means they had plenty of scope to lend more. At present, that metric stands at 70.92%. Money supply growth, which was at a low 13.4% in January 2004, is at 16.5% now. Most importantly, the level of interest rates was much lower at the time the last recovery got under way. Interest rates of bank fixed deposits of between one year and three years ranged from 4% to 5.25% in 2003-04. In 2004-05, this range went up to 5.25-5.5%.

At present, the range for deposit rates on term deposits of State Bank of India of one-three years maturity is 6.25-7%. The yield on 10-year Government of India securities was 5.19% in January 2004—at present, it’s around 7.6%. The point is that interest rates are already high for the current stage of the recovery and the risk of overheating is, therefore, much higher. That could mean a much shorter recovery than the long bull run of 2003-07.

The Reserve Bank of India expects inflation measured by the Wholesale Price Index to be 8.5% by the end of March this year—compare that with inflation at 4.8% for 2003-04. And then recall that the Centre’s fiscal deficit was 4.48% of GDP in 2003-04, which fell to 3.99% in 2004-05. This time, the fiscal deficit was budgeted at 6.85% for 2009-10. Even if the deficit is pruned next fiscal year, it will remain far higher than that for 2004-05 and will increase the upward pressure on interest rates.

Finally, the external environment is much weaker. World growth was 4.9% in 2004, according to the International Monetary Fund. This year, it’s projecting a growth of 3.9%. And 2004 didn’t have the problems that plague the financial sector in the West today, nor was growth so dependent on government stimulus.

In short, the milieu for recovery is today worse in many ways that it was in 2004. But for India, the comparisons are not all negative. The biggest positive is that we now have a stable government, not dependent on the Left. But that can make a difference only if the government seizes the opportunity to push reforms.

Manas Chakravarty takes a weekly look at trends and issues in the financial markets. Your comments are welcome at capitalaccount@livemint.com