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The answer to the question--Will Indian markets get a premium valuation amidst the global market place?--would have been an unequivocal yes, till the beginning of January 2008. But now, there are doubts being cast over this. Markets have more than halved from their peaks and the price earnings multiple, which was touching 30 times trailing earnings, too has halved to 15 times for the Sensex (^BSESN : 11134.99 0) and 13 times for the entire market.

However, this is still at a 20% premium, higher than that of emerging market peers, and much above the 7% average recorded during the past 15 years. Questions now abound about the sustainability of this premium.

Doubts emanate from the growing fiscal deficit. "The fiscal deficit, if not contained, will increase interest rates and the cost of doing business and thereby the ability to serve this capital," says a fund manager with an overseas fund. And this will have a bearing on the premium that India earns. One of the reasons that Indian markets earn their premium standing is because the return on equity is way higher, at around 20% levels, as compared to 15% levels recorded by many of its emerging market peers, he adds.

With the cost of capital and availability of credit being an impediment at a time of a slowdown and immense political uncertainty, several experts reckon that the earnings scenario will remain depressed for several quarters and the premium rating will collapse for some time till things improve substantially. And then, there are corporate governance issues, as there have been glaring short falls in corporate governance standards in case of many Indian corporates.

The Satyam (SATYAM.BO : 47.25 0) issue highlighted this matter. In a report published earlier in 2008, CLSA Asia Pacific Markets had mentioned that Indian companies earned a premium against their Asian peers due to higher corporate governance standards.

However, Ridham Desai and Sheela Rathi of Morgan Stanley, in a report that dealt with this very matter, mention, "Our conclusion is that India could end up trading at a premium to emerging markets more often than not over the coming years."

Taking a rather macro view, Desai and Rathi reckon that India's burgeoning new workers would set the pace for growth and this is an overwhelming metric that will spur earnings and prosperity.

"India is likely to add around 10 million new workers to its workforce on an annual basis. As the workforce grows, so will the savings and hence the growth rate. This will be the key driver to profit growth," they add.

However, the issue of managing capital to fund this opportunity is an immediate and opposite force to the opportunity offered by the workforce growth. "The fact is that to employ the accretion to the work force, we estimate India would need to grow at 7% or more. This means that the country is underinvested and will guzzle capital in the coming years. As India will need to keep importing capital in the medium term (a savings deficiency is corollary of the high required growth rate), a current account deficit will remain (even as it turns into a surplus later this year purely for cyclical reasons). The implication is that India will depend on global capital market cycles unless it shifts funding sources to FDI," they add.

The essence therefore is the productive use of capital, both at the national and corporate level, and rewarding investors. Corporate governance issues too are related to this factor as poor governance leads to increased cost of capital, especially in tough times. The need to service it at competitive rates also creates tremendous pressure.

As the market infrastructure improves and a younger generation takes over the majority of the earnings share, equity investing would improve as the risk profile of new investors is certainly more risk taking, note experts. This would also propel the capital markets to be better intermediary for allocating financial resources and reduce the pressure on capital requirements, going ahead.

To conclude, Desai and Rathi say, "China's average P/E premium over emerging markets has been no different from India's over the past 15 years, even though its economic growth has been far superior. The lesson is that growth alone is not the panacea for a sustained premium multiple. A glance at the sectoral P/Es suggests that India's P/E premium to emerging markets will struggle to average higher than its current level of 20% over the long term. A more plausible long-term average could be in the teens, which would still be better than the 7% average of the past 15 years."