Valuations in India compared to other emerging markets

In last weeks I had explained the fact that the
market capitalization of Indian equity markets seems on a higher side
in comparison to India's GDP. I've been able to get hold of some data
to support this claim. Here are the figures of market Cap to GDP
ratios of different countries(based on data from World bank on GDP for
FY 2004).

USA 132.2%
UK 132.1%
taiwan 87.0%
japan 80.3%
S. Koria 77.2%
India 64.9%
Russia 57.7%
Brasil 55.6%
China 22.7%

Please note that this ratio is not a single yardstick to measure the
relative valuations because the ratio depends following factors.

1. Ratio of listed companies compared to the unlisted companies (which explains why china's M.Cap/GDOP ratio is low)
2. ratio of contribution of unorganized sector to the organized sector.
3. Prospects of growth(higher the growth prospects the higher would be the ratio)
4. Interest rates (Low long term interest rates would result in higher valuations)
5. Risk premium (if the systematic risk are high the valuations would be low)

Even after accunting for expected growth I find it difficult to
justify assumtions that equities can yield 20%+ gains in coming years.
hence I believe that the markets are going to give returns of 11-13%
in next 5 years. While these returns are pretty good it implies a risk
premium of 3.5% to 5.5% over risk free rate. This may not be enough to
justify investment in stocks in general. This means that you should
concentrate your holdings into only those stocks where the prospects
of high returns justify the risk you are taking.

Posted: Aug 22, 2005

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