Asset bubble concerns in India

(Nipun Mehta is Executive Director & Head - India, SG Private Banking. The views expressed in this column are his own and do not represent those of his organisation.)

Handout photo of Nipun Mehta, Executive Director & Head - India, SG Private Banking.

By Nipun Mehta

Ever since the start of seriously large capital flows into India, since more than a decade and a half back, there has been this concern of whether the economy can absorb them.

At a time when there is ample liquidity globally and capital flows are thick towards emerging markets and towards India, inflation of asset prices will always be cause of concern either in terms of price volatility or even in terms of potential bubbles formed out of a possibility of a run of these flows.

Capital flows into India have traditionally revolved around the obvious FII and FDI flows. Over the last 6 years these have been thicker and more pronounced than earlier.

The FII flows to an extent have led to improved valuations in equity capital markets (both listed and unlisted), greater access to debt capital for the corporate sector and enhanced capital raising ability in the primary markets. FDI into various sectors has aided faster implementation of large infrastructure projects or sectors like Retail, Insurance etc.

However, we are in a situation today where, purely due to a surfeit of capital flows, equity primary market issuances are aggressively priced and are getting subscribed largely by institutional investors with limited participation by retail.

Not surprisingly, most of them are quoted at a discount post listing. Land and Real estate (which saw large infusion of foreign capital flows between 2007 & 2008) prices ran up too much too fast and almost formed a virtual bubble. We are witnessing the adverse effects of overpricing even now.

At a point in time in 2007 when huge capital flows were clearly driving stock prices, secondary markets in equities saw valuations for certain sectors being discounted 3 or 4 years forward as opposed to 1 year that markets traditionally follow. Were those valuations justified?

There’s clearly a difference between the effect of capital flows in the form of FDI or FII on asset prices in the country. There’s probably enough and more appetite for FDI flows further into India. They will not create an asset bubble, given the consistently growing size of the economy and the hunger for increasingly larger project implementation in various sectors.

It is also important to appreciate that FDI flows have a longer term outlook on their investment as opposed to FII flows which has led to intermittent asset bubbles leading to sharp price volatility, detrimental to investor interest.

At the present juncture, FDI flows into India are not a concern. In fact the country could do with more. While FII flows have been heavy in the latter part of 2009, they haven’t yet led to inflating asset prices to a level where there is serious concern.

Is this pace of flows likely to continue? If it does continue into 2010, leading to sectors or stock prices running ahead of their 2011 earnings (imminently possible), there could be a potential bubble forming.

Importantly, if for a brief moment one were to look externally and see the effect of capital flows, some potentially speculative, into various commodities like oil, gold, metals, we might just have a potential bubble forming there. Or do we?