The Economic Survey 2017-2018 warns about high stock valuations

Last Updated on

The  Economic Survey 2017-2018 was published yesterday with a clear warning that the stock market valuations are too high and unless earnings increase, a correction should be expected. The survey also argued that the bond market seems to have forgotten about the growth in the national small savings fund. Amidst the euphoria about increased GDP growth projections, this warning should be kept in mind. The economic survey can be downloaded from here.

Economic Survey 2017-2018 on bond markets

In box 8 of chapter 1, titled, “Do Government Market Borrowings Reflect the Underlying Fiscal Deficit?”, the survey explains why the sharp increase in the 10Y G-sec yield (resulting in a fall of long-term gilt and dynamic bond funds) is not backed by reason. The survey argues that the bond market seems to fear (1) the issue of new gilts to handle the fiscal deficit (which it believes to be higher than documented) and (2) higher inflation (which is reasonable). The sudden increase in yield curve is a result of this.

It adds:  “Another factor contributing to the rise in bond yields has been stepped-up Open Market Operations (OMO) by the RBI. This amounted to a net sale of about Rs. 90,000 crores during April-December 2017-18 (compared to a net redemption of Rs. 1.1 lakh crores during the same period in 2016-17).”

Economic Survey 2017-2018: Bond Yields

The yield curve is a plot of bond yields vs duration. The curves shown are above where the longer duration bonds have higher yields is known as “normal yield curves”. Read more: The Bond Yield Curve as an indicator of what’s going on with the economy

The survey points out that the bond market has forgotten that

Net Market Borrowings = Fiscal Deficit- NSSF net flows

Where NSSF is the National Small Savings Fund where PPF, SSY, SCSS, NSC, KVP, MIS, TD, PO-SB contributions go. This has seen a sudden spike in contributions.This is because after demonetization, the NSS schemes have relatively better returns and better tax treatment (PPF, SSY).

Economic Survey 2017-2018: National Small Savings Fund

Therefore, there is no need for the central government to issue more bonds to handle the fiscal deficit. It has enough funds in the NSSF.

As explained in the evolution of Public Provident Fund (PPF) Interest Rates, the state governments borrow from the small savings fund at about 2% higher interest than the rate offered to us! Therefore to decrease their spending, they preferred to issue more bonds rather than borrow from the NSSF. You can see the central borrowing has come down, while the state borrowing has increased sharply.

The bond market has incorrectly interpreted higher state borrowing as due to higher deficits. This is incorrect. The states are merely trying to borrow at a lower rate by issuing more bonds.

Economic Survey 2017-2018 on stock markets

The survey shows that although the US and Indian markets have increased by similar amounts since Dec 2015 and now have similar price-earnings ratios, the underlying reasons for the increase are quite different.

economic survey 2017-2018 US and Indian stock markets

Economic growth in the US has increased, justifying its stock market increase. Whereas in India, the economic growth has decreased.

us and Indian economic growth

In addition, the real interest rates are very different. The real rate is the savings interest rate after accounting for inflation

1 + real-rate = (1+ interest-rate) x (1+ inflation-rate)

Lower real interest rates imply business can borrow easily. In India, the rate is high, therefore more savings and less consumption, meaning, less corporate profits and therefore fewer stock earnings. So the stock market should be reflected that by not increasing so much. This means that

1: it will wait for earnings to catch up and 2: if they don’t, if oil prices remain high, if FIIs pull out, if local interest rates increase, it will correct sharply. The economic survey states this quite clearly. That is a lot of ifs there, but to quite the chief economic advisor (see presentation below): “only the paranoid survive”. (After Andrew  Groves book by the same name)

Why is the Indian stock market zooming up?

1: Investors purchased in the hope that a strong government will result in corporate earnings. As noted by me time and time again, this has not happened:

Nifty Valuation Analysis with PE, PB, Div Yield, ROE, EPS of 21 NSE Indices (Feb 2017)

Nifty Valuation Charts Nov 2016: PE, PE, Div Yield, ROE, EPS Growth (Oct 2016)

Nifty Valuation Charts: Dec 2015 (Dec 2015)

2: Post demonetization, with falling interest rates and poor returns from gold, investors turned to equity and equity mutual funds for better returns. Since the risk-free rates decreased, the extra returns that equity must provide for the risk rake ( equity risk premium – ERP) also fell.

economic survey 2017-2018 gold returns and mutual fund inflows

Equity risk premiums of US and Indian markets. See footnote on page 30 for details of calculation. This is a simple definition

Equity Risk Premium = Expected return on stocks – risk-free-rate

The survey says:

Does this imply 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 ERP. But it is worth recalling
that a similar assessment was made in the US after its ERP fell sharply in the late 1990s-early 2000s. A few years later, the
technology bubble collapsed, then the Global Financial Crisis occurred. The ERP surged to new heights and still hasn’t
reverted to its previous trough.
Beyond ERPs, sustaining current stock valuations in India also requires future earnings performance to rise to meet stillhigh
expectations. And this outlook, in turn, depends on whether a significant economic rebound is this time well and truly
around the corner

Thus the survey opines that high valuations are not justified and

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.

Should I be worried?

“Would it help?” (guess the movie!)

What should I do?

The Economic survey has only stated the obvious to those who had their feet on the ground. The market cannot keep increasing without any sign of corporate earnings. So it would either wait (sideways movement) or fall sharply if the FIIs pull out or if the Indian savers switch to fixed income when RBI increases rates. So

1: Lower expectations from equity.  The high returns you have got will eventually decrease, as sure as night follows day.

2: If your goal is several years away, do nothing.

3: If your goal is around the corner, you should not be in equity anyway! Round the corner here means within next 5 years (yeah 5 years is short-term). Why? because returns depend on market increase and time (more on this soon – we often forget about time)

4: Do not fall prey to BS from sales guys about high GDP growth, Indian shining etc. and ignore your asset allocation.

5: If you want to reduce the risk of a sharp correction, read more about tactical asset allocation models and implement it (easier said than done!)

Economic Survey 2017-2018 Presentation by the chief economic Advisor, Dr. Arvind Subramanian



Chapter 1 Economic Survey of India 2017-2018

Do share if you found this useful

About the Author M Pattabiraman author of freefincal.comM. Pattabiraman(PhD) is the author and owner of  He is an associate professor at the Indian Institute of Technology, Madras since Aug 2006. Pattu” as he is popularly known, has co-authored two print-books, You can be rich too with goal based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management.  He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. Pattu publishes unbiased, promotion-free research, analysis and holistic money management advice. Freefincal serves more than one million readers a year (2.5 million page views) with numbers based analysis on topical issues and has more than a 100 free calculators on different aspects of insurance and investment analysis. He conducts free money management sessions for corporates  and associations(see details below). Previous engagements include World Bank, RBI, BHEL, Asian Paints, TamilNadu Investors Association etc. Contact information: freefincal {at} Gmail {dot} com (sponsored posts or paid collaborations will not be entertained)
Want to conduct a sales-free "basics of money management" session in your office?
I conduct free seminars to employees or societies. Only the very basics and getting-started steps are discussed (no scary math):For example: How to define financial goals, how to save tax with a clear goal in mind; How to use a credit card for maximum benefit; When to buy a house; How to start investing; where to invest; how to invest for and after retirement etc. depending on the audience. If you are interested, you can contact me: freefincal [at] Gmail [dot] com. I can do the talk via conferencing software, so there is no cost for your company. If you want me to travel, you need to cover my airfare (I live in Chennai)

Connect with us on social media

Content Policy

Freefincal has original unbiased, conflict-of-interest-free,  topical reports, reviews, commentary and analysis on all aspects of personal finance like mutual funds, stocks, insurance etc. All guest authors and contributors to the site also do not have any conflict of interest. If you find the content useful, please consider supporting us by (1) sharing our articles and (2) disabling ad-blockers for our site if you are using one. No promotional content We do not accept sponsored posts and link exchange requests from content writers and agencies. This is our privacy policy Our website is non-profit in nature. The revenue from the advertisement will only be used for hosting charges, domain registration charges, specific plugins necessary for traffic growth and analytics services for search engine optimisation.

Do check out my books

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingMy first book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.  It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You WantGamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantMy second book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a young earner

The ultimate guide to travel by Pranav Surya

Travel-Training-Kit-Cover This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step.  Get the pdf for ₹199 (instant download)

Free Apps for your Android Phone

All calculators from our book, “You can be Rich Too” are now available on Google Play!
Install Financial Freedom App! (Google Play Store)
Install Freefincal Retirement Planner App! (Google Play Store)
Find out if you have enough to say "FU" to your employer (Google Play Store)

Blog Comment Policy

Your thoughts are vital to the health of this blog and are the driving force behind the analysis and calculators that you see here. We welcome criticism and differing opinions. I will do my very best to respond to all comments asap. Please do not include hyperlinks or email ids in the comment body. Such comments will be moderated and I reserve the right to delete the entire comment or remove the links before approving them.


  1. Excellent article Professor.

    Bridge of Spies movie Professor and Yes, it could help, to check if you had invested wrongly and if you have got time to correct that mistake.

Leave a Reply

Your email address will not be published. Required fields are marked *