The BSE Sensex, India’s premier inventory market index, has been hobbling round 50,000 factors over the previous few days. It has risen by a whopping 78% from across the finish of March, when it had fallen to 27,591 factors as Covid-19 hit India and a nationwide lockdown was introduced.

This astonishing rise has now received the Reserve Financial institution of India fearful. RBI Governor Shaktikanta Das, within the foreword to the most recent Monetary Stability Report, factors out: “The disconnect between sure segments of monetary markets and the actual financial system has been accentuating in current instances, each globally and in India.”

Individuals who run central banks don’t all the time discuss in plain English. Das is barely following custom right here. The assertion principally refers to inventory costs. Das feels they’ve risen too quick within the current previous and have turn out to be disconnected from the general financial system.

Whereas the financial system is predicted to contract this yr, the inventory market has rallied 80%. How’s this doable?

Theoretically, a doable rationalization is that the inventory market reductions the long run, and the inventory market traders suppose that the way forward for the Indian financial system is vivid. One other rationalization supplied by inventory market traders is that company income this yr have been at ranges by no means seen earlier than.

However even after taking these causes into consideration, the present degree nonetheless can’t be justified. As Das put it in his foreword: “Stretched valuations of monetary belongings pose dangers to monetary stability.” A technique to determine whether or not valuations are certainly stretched is to have a look at the price-to-earnings (P/E) ratio of the shares that represent the Sensex index.

In January 2021, the P/E ratio has been at round 34. Which means traders are able to pay Rs 34 as worth for each rupee of incomes of the shares that make up the Sensex. Such a excessive P/E ratio has by no means been seen earlier than. Not even in late 2007 and early 2008 when inventory costs rallied huge time, or within the first half of 2000 when the dotcom bubble was on.

Clearly, inventory costs are in bubbly territory. The present bounce in company earnings isn’t sustainable for the straightforward purpose that corporates have pushed up earnings by slicing worker prices in addition to uncooked materials prices. Which means the incomes of everybody linked with corporates — from staff to suppliers and contractors — have fallen.

This fall in incomes has restricted the flexibility of those people to spend cash, which can result in decrease personal consumption within the months to return, which, in flip, will impression company revenues and ultimately income. A sustainable improve in income can solely occur when individuals maintain shopping for issues and company revenues maintain going up.

This brings us again to the query, why then are inventory costs going up when the general financial system shouldn’t be doing nicely. Part of the reason being the RBI, although the central financial institution glosses over this completely within the Monetary Stability Report.

Since February 2020, the RBI has pumped in a large sum of money into the monetary system by numerous measures, a few of which contain the printing of cash. By flooding the monetary system with cash, or what central banks confer with as liquidity, the RBI has ensured that rates of interest on financial institution deposits have fallen.

The thought right here is three-fold. A drop in rates of interest permits the federal government to borrow at decrease rates of interest. This turned essential as a result of, because of the pandemic, the tax collections of the federal government have dropped this monetary yr. Between April and November 2020, the gross tax income stood at Rs 10.26 lakh crore, a drop of 12.6% compared to the identical interval in 2019.

Secondly, decrease rates of interest ensured that the curiosity price of corporates on their excellent loans got here down. Additionally, the hope was that at decrease rates of interest, corporates would borrow and increase financial exercise. Thirdly, at decrease rates of interest, the hope all the time is that folks will borrow and spend extra, and all these elements would result in a sooner financial restoration.

However there’s a flip aspect to all this. A fall in rates of interest on deposits has harm the unusual depositor, particularly senior residents, and despatched individuals in search of a better return. This has led to many people shopping for shares, within the hope of a better return, thus driving up inventory costs to astonishingly excessive ranges.

This may be gauged from the truth that in 2020, the variety of demat accounts, that are essential to purchase and promote shares, went up by practically a fourth to 4.86 crore accounts. This additionally reveals the rise of ‘Robinhood investing’ in India. The time period comes from the American inventory brokerage agency Robinhood, which gives free on-line buying and selling in shares. India has seen the rise of comparable inventory brokerages providing free buying and selling.

What has added to all that is the truth that many people now out of jobs have turned to inventory buying and selling to make a fast buck. All it wants is a smartphone, an affordable web connection and a low-cost brokerage account.

In fact, this seek for a better return isn’t native, it’s world. Therefore, overseas institutional traders have invested a whopping $31.6 billion in Indian shares throughout this monetary yr, the very best ever. This stems from the truth that just like the RBI, central banks within the West have additionally printed an enormous sum of money to drive down rates of interest. This has pushed increasingly more traders into shopping for shares even supposing the worldwide financial system isn’t doing nicely both.