Discovery of India

The Sensex has risen around 16 per cent in the last couple of months, and the ebullience is not restricted to the frontline stocks alone. Both the BSE Midcap Index and the BSE Small Cap Index have also risen by a similar percentage.

The main reason for the rally, of course, has been the huge amount of money pumped in by foreign institutional investors into the Indian market "" in June and July, net purchases of Indian equities by FIIs added up to over $3 billion. Add to that recent buying by the domestic mutual funds, and you have a bull run in the market.

Note that the market has been ignoring all the recent bad news, including record crude oil prices, the losses on account of the rains in Mumbai, the fire at the ONGC platform and the diminishing scope for reform on account of opposition by the Left. That's a sure sign of a bull market.

The question is "" is the exuberance irrational? To be sure, the markets have gone up too far too fast and a correction is overdue. But that's in the nature of markets, and what is important is not whether there will be a correction in the short-term, but whether investment in Indian equities is justified even at the current high valuations.

One reason for the rally advanced by the bulls is that the first quarter corporate results have been better than expected. There are few markets among emerging countries with the breadth of choice available in the Indian market, and few companies that show the kind of growth rates that Indian corporates have been notching up.

Perhaps more importantly, new investors have been discovering the India growth story, and these range from pension funds in the US to Japanese and Korean funds.

The strength of the rupee, too, has played a part, and dedicated India funds have been attracting very strong inflows. Many global investors believe that India today is where China was in the eighties, poised for explosive growth. The consequence of all this has been that the Indian stock market is awash in liquidity.

Unfortunately for the India-centric story that relies on the solid fundamentals of Indian companies, markets across the world have also been rallying. In the US, the S&P 500 and the Nasdaq have both recorded four-year highs.

Markets as diverse as Australia, Singapore and Hong Kong have all been driven to four or five-year highs, with the South Korean market jumping to a 10-year peak. This collective bullishness has prompted some analysts to predict higher global growth, particularly in the US and Japan.

On the other hand, the bears have for long been saying that the two-year old rally in the emerging markets has been driven by liquidity, and by hedge funds maximising the scope for borrowing at low interest rates. They have explained away the lack of reaction to rising US policy rates by pointing to the fact that real interest rates remain very low.

Whatever be the truth of the matter, the fact remains that, at current levels, risks have increased for investments in equities. Valuations may indeed remain high so long as fund flows remain strong, and it's true that many recent entrants into the Indian market are long-term players.

Nevertheless, considering how all emerging market assets tumbled in mid-March when risk aversion buffeted the markets, caution needs to be the watchword of investors at this time.