There is no positive news on Indian economy. The declining Index of Industrial Production has already sent strong signals of a slowing economy. Adding to the gloom is a deficient monsoon, which is pushing prices and squeezing rural income. And the government is not showing any political will to take up any meaningful reforms. The only indicator that is up, interestingly, is the Sensex.
The RBI at its last policy review cut the GDP growth estimate to 5.5 percent. The Prime Minister's Economic Advisory Council (PMEAC) followed, as it slashed the estimate by almost 1 percentage point to 6.7%. A slew of foreign brokerages, such as Nomura and Morgan Stanley, have pegged the GDP growth even lower--at sub-6 percent.
Moreover, Finance Minister P Chidambaram has failed to keep his promise, as he is yet to show his resolve to take some hard decisions.
With the Opposition stalling Parliament over coal block allocation scam, a political logjam has been created and no reforms can be expected in the near future.
Whatsoever the political economic situation is, the Sensex has gained around 16.5 percent so far this year, and around 3 percent in August alone.However, at the same time global crude prices have risen 28 percent in the last three months alone. A rising crude oil price is a key risk for India's macro outlook and performance of Indian equities, but the markets continue to hold strong.
So what is driving the rally?
Foreign institutional investors have poured in $11.5 billion into Indian equities this year, according to market research and brokerage firm IIFL. That is the most this year among 10 Asian markets.
In contrast, domestic institutional investors have been sellers. In the cash segment, barring June when they bought 58 million dollar worth of shares, domestic mutual funds have been net sellers.
FIIs, meanwhile, have been net buyers, baring two months, April and May, when the sold a total of $376 million worth of shares.
"This has probably dampened market moves on either side but it is the foreign investor/ flow that continues to drive the market," said Citi in a report.
But why are FIIs fuelling the rally here?
Federal Reserve policy makers in the US have signalled more stimulus measures to shore up US GDP growth, triggering speculation of increase demand for risky assets like emerging-market stocks and currencies, which is why equities across the world have performed well.
Secondly the markets are also convinced that the European Central Bank will, sooner or later, intervene in the market to buy bonds of troubled countries such as Spain and Italy after ECB Draghi promised that it would do whatever it takes to save the euro.
"Both the ECB and the US Fed have given clear statement which suggests that they are willing to do whatever it takes to prevent any kind of a major slowdown developing from here. So that has given people some confidence and that has created the risk-on trade," Arvind Sanger, managing partner, Geosphere Capital Management told CNBC-TV18.
A report in Mint pointed out that fund managers globally are sitting on enough cash to fuel the rally further. "According to the Bank of America-Merrill Lynch survey for August, cash levels with funds stand at 4.7%. Given that the survey is seen as a contrarian signal, this could suggest further gains," it said.
Are the bulls getting edgy?
And India, like its emerging market peers has benefited from the risk-on trade on a global basis. However,Sanger cautions that India-specific fundamentals are too weak to sustain this rally. The real challenges, he says are monsoon and food inflation which has also causes RBI policy to stay on hold.
Even market analyst Ambareesh Baliga agrees that Nifty may test 5,500-5,600 level aided by the gush of liquidity, but these levels are unsustainable for a longer period given that mounting political chaos and policy inaction continues to remain an overhang for the market.
The current political environment puts a question mark on all the markets reform expectations being met. The global environment remains challenging too - with weak data flow being offset by expectations of more quantitative easing, said JP Morgan in a research report today.