Rational exuberance

The reaction of the stock market to the Union Budget has been mildly euphoric, as seen from the Sensex hitting new highs every day. Foreign institutional investors have voted with their money, pumping in huge amounts of cash into the market.

At first sight, this seems like "irrational exuberance", since the Budget didn't do much for reform, and while it did lower direct taxes, the fine print has since disclosed that Mr Chidambaram more than takes away with the left hand what he gives with the right.

Also, apart from allowing FIIs to put up non-cash margins in derivatives, and allow losses in the futures and options segments to be set off against business income, the Budget didn't really have any benefits aimed specifically at market participants.

Meanwhile, the Securities and Exchange Board of India has carried on the good work of improving market microstructure by further fine-tuning the norms for margin trading. But none of these""the Union Budget, the sops for FIIs, the improvement in markets""is really responsible for the new heights being scaled by the market indices.

Rather, the predominant feeling in the markets is one of relief that the Budget is now out of the way and nothing now holds the Indian market back from rising once again on the tide of liquidity that is flowing into the emerging markets.

The most recent data show that the February flows into emerging market equity funds were at their strongest in the last decade. The boom in the Indian market in the last couple of years has been part and parcel of that flow.

And even though the markets may be worried about the impact of the fringe benefits tax, and the effect of changes in customs and excise duties on some sectors, these concerns are washed away by the deluge of money. Add to that the resources being raised by domestic mutual funds, and we may shortly see mutual funds too turning into net buyers, adding to the demand.

Will the momentum be sustained? The larger story driving the diversification into emerging markets is the demographic change in the developed countries and the problems in funding their pensions, which has led to a search for higher-yielding assets.

This is the stable part of the funds flow, the symbols of which are Calpers and Fidelity. At the same time, there are the highly leveraged hedge funds that dart in and out of assets. So while there may well be a secular rise in investment in emerging market assets, this is likely to be accompanied by much volatility.

So far as the Indian market is concerned, the attraction is that earnings growth continues to be strong, the India story has been sold well, and anecdotal evidence points to plenty of money being raised for investment into the country.

To be sure, concerns remain about the impact of rising interest rates in the US and about how global imbalances will finally be resolved. But there is no denying that, at the moment, things could scarcely get better for the market.

This would have been the ideal time for the government to gather large amounts of cash by divesting its stakes in companies and by floating its unlisted enterprises. That would have broadened the market and raised much-needed resources for funding infrastructure. It is a pity that political constraints rule out that opportunity.