Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

The odd thing about India's stock market rally is just how little faith investors have in it. 

The Nifty 50 Index is barely 2 percent away from its all-time intraday high, but unlike the S&P 500 Index, which has closed at records 13 times this year, the Indian benchmark is struggling to break free of skepticism.

There isn't an awful lot of demand for downside protection in the options market, despite a crucial state election result expected this Saturday. But even with some exit polls signaling a win for Prime Minister Narendra Modi's party, traders aren't exactly brimming with confidence. Bank of America Merrill Lynch has warned investors there may be "room for disappointment," while fourth-quarter GDP growth of 7 percent failed to spur analysts' optimism on the outlook for corporate earnings.

All Tumult From My Bosom Fades
Many global stock benchmarks are more than one standard deviation quieter than their three-year average, but not India's Nifty
Source: Bloomberg
* For at-the-money, near-month options.

Given the froth in markets globally, some nervousness is to be expected. Yet what prevails elsewhere is an eerie confidence. Option prices on national benchmarks in Japan, China, Germany, the U.K. and the U.S. are all signaling more carefree abandon than contracts on the Nifty, for which the one-month implied volatility is a mere 0.64 standard deviation below its three-year average.

Foreign investors are circumspect. They put a net $3 billion into Indian stocks last year, compared with a $43 billion deluge into domestic mutual funds. Local liquidity is strong because the government's November ban on high-denomination banknotes has dented demand for property and gold. Limited appetite for assets that are bought and sold for cash has left stocks as the only option for wealth owners.

Home Money Leads
As foreign investment in India's stock markets tapers off, inflows into local mutual funds have touched a nine-year high
Source: Bloomberg

Barring software and pharmaceutical exporters, which are bogged down by concerns about U.S. President Donald Trump's policies on immigration and imports, nothing in the Indian index is cheap. BNP Paribas SA says valuations are running 50 percent ahead of regional peers. Liquidity alone may not keep stocks afloat, especially if rising U.S. interest rates trigger a sudden investor withdrawal from emerging markets.

If pessimists' wait for a tumble gets longer, put it down to special situations. Shares of Reliance Industries Ltd. got a boost recently when Jio, the company's new fourth-generation mobile network, went from being a freebie to a paid service. Jio's entry sent a retreating Telenor ASA into the arms of India's mobile market leader Bharti Airtel Ltd., while Vodafone Group Plc is getting the local public listing it's long craved by agreeing to merge with Idea Cellular Ltd.

All this comes at a time when big-ticket dealmaking by India Inc. is five to 10 years in the past. Tata Steel Ltd.'s $12 billion acquisition of Corus Group Plc's steel assets, and Hindalco Industries Ltd.'s $5.7 billion takeover of Atlanta-based Novelis Inc., are of a 2007 vintage. Vedanta Resources Plc bought a stake in oil producer Cairn India in 2011.

A fresh cycle began only last year, with billionaire Kumar Mangalam Birla starting to reorganize his cement-to-telecom empire, and a $13 billion sale of Essar Oil Ltd. by the Ruia brothers. Last month, Tata Steel agreed to offload its U.K. specialty steels unit to Liberty House Group to pare debt, and now the government in New Delhi is seeking to merge a state-owned oil explorer with a refiner.

Profit Holds the Key
The return on equity on BSE 100 stocks* has dropped, led by a decline in Indian corporate profitability
Source: Bloomberg
*Excluding banks, insurers and finance companies.

What will all this mean for shareholders? Take telecom. As consolidation cuts carriers' spectrum costs, the debt overhang in India's wireless industry should ease. A similar scenario may play out in everything from banks to steel and infrastructure, cement and real estate. As Morgan Stanley notes, industries with the least pricing power -- or facing the most distress -- are prime candidates for M&A activity.

That offers hope for a revival in returns on equity. Shrinking corporate profitability is the main reason why total gains for the 75 biggest non-finance companies on the Bombay Stock Exchange have slumped from an average 18 percent five years ago to 13 percent. With less leverage and improved earnings, a growing stock-market rally in India should gather more believers than cynics.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Andy Mukherjee in Singapore at

To contact the editor responsible for this story:
Matthew Brooker at