On 4th June, the Lok Sabha election results shocked the market and jolted the ruling Bharatiya Janata Party. But the market was perturbed for barely two hours. By noon, stocks started recovering and, within a week, surpassed the all-time high it had hit just before the election results. A month later, as the steady upward drift continued, the indices were much higher still, belying worries about a hobbled minority government.
On the day that the Union budget was announced, markets fell due to the imposition of higher taxes on capital gains. Investors took two days to digest the uninspiring Budget provisions. On the third day after the Budget, indices charged up again, recording handsome gains.
Internationally, wars are raging in Ukraine and the Middle East which has pushed up shipping costs and time.
Domestically, worries include an electoral setback for the ruling party, poor consumption, jobless growth and high actual inflation, combined with extreme valuations in certain pockets of the market. And yet, the market is scaling new highs. What gives? With the benefit of hindsight, here is the set of factors that are fuelling the bull market.
Government Spending: For the first five years, the Modi government tried many tricks, but struggled to generate much economic growth. In September 2019, the government slashed corporate taxes in the belief that businessmen would use the money saved to invest and expand. Grateful businessmen mostly held on to the savings, partly spending it on dividends and buybacks. They did not invest more and tax cuts failed to create jobs.
During COVID-19, the government was forced to adopt reflationary tactics to keep the economy going, which boosted economic growth and led to higher stock prices. A higher growth, combined with high rates of goods and services tax (GST) and strict enforcement of GST rules, led to booming revenues for the government, giving it elbow room for a second gamble—massive capital expenditure (capex) by the government in highways, expressways, railways, waterworks, energy and defence. This kicked off huge growth for a large number of listed companies, many in the small and mid-cap space, which is why these indices have done much better than the large-cap stocks.
The government has not given up on nudging corporates into investing. First, it brought back tax on dividends. Then, Budget 2024-25 announced that investors would be taxed when a company buys back its shares, with the payout treated as dividend income and taxed as per their income slab. Until now, companies have had to pay a 20% tax rate on share buybacks. The idea is to discourage corporates giving back surplus money to investors; it wants them to spend money on expansions and job-creation.
Savings Pattern: For decades, capital-market evangelists have dreamt of converting the middle-class from investing in safe but low-return bank deposits into higher-return stocks. For a variety of reasons, this did not happen, mainly because India has not had a long secular bull run.
The 2003-07 bull market was marred by two major crashes in 2004 and 2006. In 2008, an epic global crash that lasted for almost a year, killed any interest in stocks.
The current bull run that started in May 2020 has been punctuated by minor declines in mid-2022 and early 2023. It has drawn in more and more investors. After years of poor returns from all other asset classes, investors have finally embraced equities.
In 2020, after 24 years, the number of demat accounts was four crore. It has now jumped to 16.2 crore, unleashing a massive flood of investment, which is reflected in soaring stock prices – but the rise is backed by strong earnings growth as well.
Liquidity: With government expenditure boosting growth and savings ready to be invested into stocks, liquidity has done the rest. Rising prosperity in urban and semi-urban pockets and increasing corruption (leaching off massive State spending) have led to higher liquidity.
From the public interest angle, this has created a lopsided economy – a K-shaped one – as a few people do well and the majority do not. But the consequence has been a stock boom of epic proportions. Just as nothing can stand in the way of a river in full flow, a torrent of money coming from Indian investors either directly into stocks, or indirectly via mutual funds has pushed markets to higher levels. Adding to liquidity are foreign investors. In four of the first five months of this year, foreign investors were big sellers, but they have changed tack and are now sailing with the wind.
The question is: Will these factors remain in place and allow the bull to continue indefinitely? It all depends on continued growth in government revenues. If it slows down, lavish capex spending—the only engine that is driving most businesses and pushing the market upwards—will slow down.
Already GST revenue growth appears to be down to single digits, which is probably why the government has decided not to publish monthly data anymore. But investors are primarily betting on the Modi government.
Mr Modi gives the impression that it does not matter that he does not have an absolute majority anymore. He has retained the same team and is continuing with the same policies. This has worked well for the past three years. Investors find this comforting and, hence, expect the growth—and the bull market—to continue, never mind the pinpricks of higher taxes.
(This article first appeared in Business Standard newspaper)
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