Central bank sees no bubble in stock markets

RBI was worried about risks faced India's software exports due to protectionist policies like H1-B

The central bank does not see a bubble in the stock market despite high valuations. 

“No bubble is detected currently when stock prices have reached historical highs. The current rally in stock prices seems to reflect the strong macro fundamentals of the Indian economy, easy liquidity conditions prevailing in the system and buoyancy in global markets. Nonetheless, a constant vigil of stock prices may be warranted at this juncture, keeping in view the ramifications for financial and price stability,” said the Reserve Bank of India (RBI) in its annual report for FY17.

According to the RBI, a sensitivity analysis of current account deficit to gross domestic product (GDP) ratio suggested the Indian real effective exchange rate (REER) as of June 2017 was broadly aligned to its fair value to being moderately undervalued. “To sum up, despite minor blips, the INR (Indian rupee) real exchange rate remained closely aligned to its fair value over the long term.”

The central bank was, however, worried about the risks to India’s external sector resilience arising out of a slowdown in software exports. “India’s software exports — a major source of financing merchandise trade deficit — face heightened uncertainty from protectionist policies being envisaged in advanced economies, especially with regard to H1B visa in the US, which may stress the current balance of payment,” said the annual report. 

Others risks to India’s current account deficit resilience included a projected higher international commodity prices, poor export growth and lower remittances from the Persian Gulf countries.

The annual report also raised a red flag about the growing share of consumption expenditure — both private and government — in incremental GDP growth. According to the RBI, this might result in higher household indebtedness and threaten the sustainability of India’s growth model in the longer term. It cited a study in the US (Dynan 2012) to buttress its point. “Consumption-led growth can arguably lead to a slackening of future growth if it entails growing imbalances due to limits to capacity creation, and rising debt burden, particularly for households. Evidently, while borrowings helped smoothen private consumption in the short run after the recession of 2001-02, excessive leverage led to the debt-servicing burden which, in turn, debilitated consumption and overall growth during 2007 to 2009 in the US.”

“Consumption-led growth did have, albeit not statistically significant, a negative impact on consumption growth one year ahead. These results corroborate the imperative for a judicious balance in the growth drivers for non-disruptive and sustainable long-term growth,” the report said.

Private and government final consumption expenditure accounted for a bulk of FY17 GDP growth, with negligible contribution coming from growth in investment and net exports, it added.