RBI concerned about the risk of ‘Bubble’ in the Indian equity markets

The Reserve Bank of India governor showed his concerns about the sharp misalignment between the stock market rally and the actual state of the Indian economy. 

On Thursday, the RBI governor Shashikanta Das raised a red flag on the surge in the Indian stock market against the contraction of the Indian GDP.

The deviation of the actual price/equity ratio from its past long-run trend reflects the overvaluation. The Sensex is currently trading at a price to earnings (P/E) ratio of 32. Further, measures of dividend yield also signal the overpricing of the markets. 

The RBI governor noted that ‘This order of the asset price inflation as against the contraction of GDP by 8 per cent poses a risk of a bubble in the Indian equity market’.

In the annual report for fiscal 2020-21, RBI stated that the Indian equity markets have been surging high. The index crossed the 50,000 thresholds in January 2021 and further reached another high, crossing the 52,000 mark in February 2021. This is almost a 100 per cent increase in the index since the start of the nationwide lockdown.

Despite the economy’s contraction in the economy, the RBI governor said that the surge in the equity markets was mainly fueled due to the global surplus liquidity and might be a bubble in the stock market. Though future economic prospects also play a role in the movement of the stock market, the significant impact is on the money supply and foreign portfolio investments. 

Furthermore, RBI stated that the liquidity measures to support the economic recovery might result in unintended inflation in asset prices; hence it cannot be offered without any restraints due to these consequences. This is a hint from RBI that there is a need to unwind once the country can flatten the second wave and start its trajectory towards economic recovery.

For any clarifications/feedback on the topic, please contact the writer at jyoti.arora@cleartax.in

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