Have cash, will buy

It would be comforting to believe that the Sensex crossing the 6,000 mark is another indication of the strength of the Indian economy, and a happy ending to unfounded worries about the new government's policies.

Unfortunately, while the outlook on the economy is still cheerful, the market run-up has more to do with liquidity than with rising company earnings. The sell-off in the markets in May occurred across emerging markets, with the plunge in India deepened by the change of government.

Now, when the market has bounced back, it's because Asian markets as a whole have been doing well. It's not just the Indian equity markets that are rallying""the MSCI Emerging Markets Asia index is up 5.916 per cent this month.

The MSCI China index is up 7.2 per cent, the Indonesia index is up 10.1 per cent and Taiwan is up 6.7 per cent, compared to the MSCI India Index's rise of 6.3 per cent this month. And it's not just emerging markets that are doing well""the MSCI World Index has moved up 4.1 per cent this month, with the MSCI US index up by 4.6 per cent.

These figures prove that November has been a good month for stock markets across the world, and the rise in the Sensex is part of that global trend.

Based on the fundamentals alone, there's not much difference between profit growth in the second quarter and that in the first quarter for the companies that make up the Sensex. There hasn't been any acceleration in growth sharp enough to warrant a re-rating.

On the contrary, cost pressures have increased and there has been some margin compression in most sectors. With rising interest rates, and higher fuel and increasing raw material prices, the pressure on margins is likely to persist.

Going forward, the effect of the higher base will also be felt more keenly, and earnings growth could slow. With many companies reaching capacity limits, that would slow top line growth also.

Sure, companies will be expanding capacity, and an increase in investment demand, obvious from the bulging order books of capital goods companies, will drive profits going forward, but it will take time for this to be reflected in revenues and profits.

These are probably the reasons for the recent fall in the Confederation of Indian Industry's Business Confidence Index.

That does not mean, however, that the outlook for the Indian equity market is gloomy. The most encouraging fact is that, unlike a decade ago, monetary tightening in the United States has not led to a wholesale withdrawal of funds from emerging markets.

This time, emerging market flows have proved remarkably resilient to interest rate hikes in the US, proving conclusively that 2004 is not 1994. The outlook for liquidity flows to emerging markets continues to be strong, the weak dollar being a very favourable factor.

Moreover, the India story is now well-established, and with new FIIs coming to these shores and the interest being taken by pension funds such as Calpers, FII inflows are likely to continue. And even if there is a slowdown in earnings, Indian companies will continue to be among the fastest growing in the world.