The day-dwellers of Dalal Street are known to be smart at reading between the lines. In the run-up to the forthcoming budget, the Economic Survey 2017-18 released by the government foresees India’s real GDP growth reaching 6.75% for the year as a whole, rising to 7%-7.50% in 2018-19, thereby re-instating India as the world’s fastest growing major economy.

This projection, along with the positive after-effects of the Goods and Services Tax, was ample reason for the 30-stock S&P BSE Sensex to hit a life-high at 36,443.98, within two minutes of the survey’s release to the general public.

Clearly, the bulls are not willing to be tamed. Not even by the government flagging off concerns about sharply elevated stock prices. “Policy vigilance will be necessary in the coming year, especially if high international oil prices persist or elevated stock prices correct sharply, provoking a sudden stall in capital flows,” the survey highlighted.

The survey elaborated that one eventuality to guard against is a classic emerging market “sudden stall” induced by sharp corrections to elevated stock prices. However, in a self-contradictory tone the survey added, “India’s stock price surge is different from that in other countries but does not warrant sanguineness about its sustainability.”

A three-page note titled ‘Understanding the Stock Market Boom: Is India Different?’, is part of the survey in which the Indian boom is compared to that of the U.S. Quoting the past two fiscal years, the survey highlights that the Indian stock market has soared, outperforming many other major markets. “Since end-December 2015, the S&P index has surged 45%, while the Sensex has surged 46% in rupee terms and 52% in dollar terms,” it says. “This has led to a convergence in the price-earnings ratios of the Indian stock market to that of the US at a lofty level of about 26.”

Yet over this period the Indian and US economies have been following different paths. So what explains the sudden convergence in stock markets?

Before we talk about how the government makes those differences, here's the logic that Fortune India uses to call the comparison between India and the U.S. unfair. Every year , in the flagship Fortune India 500 issue we make a point to look at the three big economic powerhouses – the United States, China and India – through key macroeconomic parameters and of course the 500 aggregates (revenue and profit). Clearly, India is a fraction of the size of the US, when seen through the revenues and profits of the 500 largest corporations of the respective economies.

Here's how the government views these differences - One, the stock market surge in India has coincided with a deceleration in economic growth, whereas in the U.S. Two, India’s current corporate earnings/GDP ratio has been sliding since the global financial crisis, falling to just 3.5%, while profits in the U.S. have remained a healthy 9% of GDP. “Moreover, the recently legislated tax cuts in the United States are likely to increase post-tax earnings,” the survey says. Finally, and most critically, real interest rates have diverged substantially. Rates in the U.S. have persisted at negative levels, while those in India have risen to historically high levels. “Over the period of the boom, United States real rates have averaged -1.0%, compared to India’s 2.2%, a difference of 3.2%,” according to the survey.

What then explains the stock market convergence? Two factors seem to be at work, the survey points out. First, expectations of earnings growth are much higher in India. “Indeed, it was such expectations that lie at the origin of the stock market boom,” the survey points out. In early 2016-17, signs emerged that the long slide in the corporate profits/GDP ratio might finally be coming to an end. Investors reacted to this news with alacrity, bidding up share prices in anticipation of a recovery they hoped lay just ahead. Accordingly, the ratio of prices to current earnings rose sharply. By 2017-18 signs began to accumulate that the profit recovery was not obviously around the corner. But at that point a second factor gave the market further impetus. That factor was demonetisation.

In a tutoring manner, the survey preaches: “the price of an asset is not solely determined by the expected return on that asset. It is also determined by the returns available on other assets.” In a bid to glorify demonetisation, the survey quotes last year’s Economic Survey, which had said that the government’s campaign against illicit wealth over the past few years -exemplified by demonetisation- has in effect imposed a tax on certain activities, specifically the holding of cash, property, or gold. Cash transactions have been regulated; reporting requirements for the acquisition of gold and property have been stiffened.

In addition, rupee returns to holding gold have plunged since mid-2016, turning negative since mid-2017. Previously, stock prices had suffered because reporting requirements were higher on shares than purchases of other asset. But the attack on illicit wealth has helped level the playing field. “All of this has caused investors to re-evaluate the attractiveness of stocks,” the survey says. Investors have accordingly reallocated their portfolios toward shares, with inflows through stock mutual funds, in particular, amounting in 2016-17 to five times their previous year’s level.

The survey further says that the equity risk premium (the extra return required on shares compared with other assets) has fallen. The survey questions if this implies that Indian P/E ratios have reached a higher ‘new normal’?

“Perhaps. It’s possible that the portfolio shift set in train by the campaign against illicit wealth will result in a sustained reduction in the equity risk premium,” it says.

But it is worth recalling that a similar assessment was made in the U.S. after its equity risk premium fell sharply in the late 1990s-early 2000s. A few years later, the technology bubble collapsed, then the global financial crisis occurred.

“The equity risk premium surged to new heights and still hasn’t reverted to its previous trough,” the survey warns. The direct comparison of the black swan situations in the United States, with that of the after-effects of government-induced actions like demonetisation is not an apples to apples comparison. And then, beyond the size of the two economies and the complexities tied to the economy size, it is also about the developed and emerging economy tags which put the two economies in different leagues.

Beyond equity risk premium, sustaining current stock valuations in India also requires future earnings performance to rise to meet still high expectations. “And this outlook, in turn, depends on whether a significant economic rebound is this time well and truly around the corner,” the survey says.

But should the government really worry about the stock markets? That seems to suggest that the government does not want the stakeholders to be caught off-guard. But the two statements, when read as one, seem to indicate that generally the government is not too bullish. “Sustaining these valuations will require future growth in the economy and earnings in line with current expectations, and require the portfolio re-allocation to be semi-permanent. Otherwise, the possibility of a correction in them cannot be ruled out.”

The S&P BSE Sensex closed 232.81 (+0.65%) points higher at 36,283.25 – just 160.74 points below the new life-time high of 36,443.98. The bulls seem to be in no mood of caution.

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