At 88%, India's market cap-to-GDP ratio is now highest in 12 quarters

The Indian equity market continues to scale new highs, moving in tandem with the upswing in global markets after the election victory of Joe Biden in the US Presidential elections. On Saturday, the combined market capitalisation (m-cap) of all listed and traded companies on the BSE reached a fresh all-time high of Rs 169.3 trillion — nearly Rs 6 trillion higher than the pre-Covid high of Rs 163 trillion.

As a result, there has been sharp rise in India’s m-cap-to-gross domestic product (GDP) ratio — a key ratio used by many analysts to gauge the valuation of the broader equity market in a country. At 88 per cent currently, India’s m-cap-to-GDP ratio is now at the highest level in the past 12 quarters and nearly 12 per cent more expensive than the historical average ratio of around 78.5 per cent. In comparison, the ratio was 56 per cent at the end of March this year and 78 per cent at the end of December 2019.

In the past 15 years, the ratio has ranged from a low of 52 per cent in March 2005 to a record high of around 150 per cent at the end of December 2007, with the median value being 78.5 per cent.

India’s nominal GDP was around Rs 192.3 trillion at the end of June this year, against BSE-listed companies’ combined m-cap of Rs 169.3 trillion on Saturday.

The market is also trading at close to peak valuation when measured in price-to-earnings (P/E) multiple and price-to-book (P/B) value.

India’s nominal GDP (on a trailing four-quarter basis) is down 1 per cent in the past one year, while the combined m-cap of all listed companies is up 9 per cent during the period. The GDP data is based on growth estimates for the April-June quarter.

India’s GDP (on a trailing four-quarter basis) is expected to move lower once the National Statistical Office releases GDP estimates for the July-September period at the end of this month.

Many analysts are, however, wary of using GDP as a marker for m-cap. “There is no direct link between GDP and m-cap. This especially true in India where listed companies represent only a small fraction of India’s overall GDP,” says G Chokkalingam, founder and managing director, Equinomics Research & Advisory Services.  

According to him, corporate earnings and balance sheet numbers such the net worth or book value are a better marker of equity valuation than GDP.

Others see only a weak link between stock valuations and the underlying economic and corporate fundamentals, given the surge in global liquidity after Covid-19.

“Honestly, there is no upward limit on m-cap-to-GDP ratio, given the gush of liquidity in global markets thanks to aggressive monetary expansion by major central banks,” says Dhananjay Sinha, head research Systematix Institutional Equities.  

He sees more upside in m-cap from the current levels, given the strong buying by foreign portfolio investors (FPIs) in recent weeks. “I expect more buying by FPIs as capital inflows into India have so far lagged the pace of monetary expansion by major central banks,” adds Sinha.

Analysts also point out to the weakening of the link between India’s GDP and corporate earnings. In the past five years, while India’s headline GDP is up by 44 per cent cumulatively, corporate earnings are almost flat, and the BSE m-cap is up 69 per cent during the period.

As a result, while m-cap-to-GDP ratio has moved in a tight range of 70-80 per cent in the last five-years the broader market had become progressively expensive on P/E multiple basis. Here we have used the Nifty50 index valuation as a proxy for the overall market valuation.

The benchmark index Nifty50 is currently trading at 35x its trailing 12-month earnings and nearly 20 per cent higher than the pre-pandemic valuation. “I think 35x is now a fair earnings multiple for the Nifty, given the liquidity situation. This was around 28-29x before the pandemic,” says Sinha.

In comparison, the Nifty is currently trading at 3.6x its trailing P/B value, slightly higher than the 15-year average of 3.5x, but less than half the ratio in the pre-Lehman era. Analysts, however, attribute the decline in P/B ratio to the rise of asset-heavy companies such as lenders and Reliance Industries (RIL) on the index rather than its lower valuation. Lenders and RIL together account for nearly half the Nifty50 index.