(Sarvesh Kumar Sharma/Mint )
(Sarvesh Kumar Sharma/Mint )

Markets riding on hope that things can only get better from here on

  • Indian markets responded to dire economic news by sending key indices to record highs
  • Investors hoping that weak economic data will prompt a heavy-duty stimulus from policymakers

When you’re down you have nowhere to go but up, goes the old saying. It’s something traders in the Indian stock markets seem to believe in fiercely.

On 31 May, the government released data according to which growth in gross domestic product has hit a five-year low in FY19. Simultaneously, it said the unemployment rate stood at 6.1% in FY18, the worst in 45 years.

The stock markets responded to all this dire news by sending benchmark indices to record highs.

“It’s the typical reasoning of the markets that the worse economic data gets, the higher the chances of a concerted effort by the government and the central bank to get the economy going again," said the head of research at an institutional brokerage firm, who declined to be named. “Over the weekend, the number of people expecting a 50 basis points cut in interest rates in the June policy meet has evidently increased."

As such, the focus of markets is on how things can improve with the help of a monetary stimulus, rather than being bogged down by how bad things are at present.

“The market has high hopes of reforms from the newly elected NDA government and monetary stimulus from the RBI," analysts at Kotak Institutional Equities said in a note to clients.

The irony in all of this is that while the economy may be near rock-bottom and may have nowhere to go but up, the markets are at record highs.

As another old saying goes, what goes up must come down. “We find the valuations of the Indian market full on a top-down basis, with the Nifty 50 index trading at 19.5 times estimated FY20 earnings on a free-float basis," added the analysts at Kotak.

Investors are evidently riding on the hope that a monetary stimulus is not only a given, but also that it will largely solve the multiple problems the economy is facing. There’s not much point banking on a large fiscal stimulus as well. “With limited fiscal room, the RBI would need to do the heavy-lifting on policy stimulus measures," analysts at (brokerage firm Jefferies India Pvt. Ltd said in a note to clients.

Indeed the stock markets should be worried about the high possibility of fiscal slippage in the current fiscal year. This is largely because collections under the goods and services tax (GST) have been short of target in the first two months.

“Even if GST collections rebound in the rest of FY20 and the 0.9 trillion divestment target is met, net receipts may still fall short...that would imply a 50bps (basis points) slippage to 3.85%, the highest since FY16," added the analysts at Jefferies India.

However, with the mood the markets are in, traders may well cheer a widening of the deficit on the hope that it may drive the economy at some point in the future.