Mumbai: The sale price of an apartment in central Mumbai last week is one indication that high asset prices could be beginning to trouble the Reserve Bank of India (RBI) ahead of its annual monetary policy statement on 20 April.
Royal Bank of Scotland Plc sold an apartment in Mumbai’s Worli area for Rs37.25 crore in one of the city’s most expensive residential real estate transaction. While real estate analysts cautioned that too much shouldn’t be read from one-off deals such as this, property prices in India are flirting with levels last seen before the 2008 financial crisis.
Property is not the only asset class to have risen. The sharp rebound in equity prices after March 2009 has taken them quite close to their peak levels during the boom years. The benchmark Sensex is now 15% below its January 2008 peak of 21,206.77. And precious metals have not been laggards either.
Gold last week climbed to the highest price since December. The price as on 9 April for June delivery was Rs16,825 for 10 grams, according to Multi Commodity Exchange data. That’s a rise of 57% in the past two years.
To be sure, the Indian central bank’s main concern now is the rising prices of goods and services rather than prices of equities, housing and precious metals. Inflation measured by the Wholesale Price Index for February came in at 9.89%, the highest for any major economy, and the new inflation data to be released later this week is widely expected to show double-digit inflation for March.
The combination of a strong economic recovery and high inflation has forced RBI to push interest rates up ahead of most other global central banks. In March, RBI increased the benchmark reverse repurchase rate to 3.5% from 3.25% and the repurchase rate to 5% from 4.75%.
“Asset price inflation creates risk for financial stability,” said Rupa Rege Nitsure, chief economist at state-owned Bank of Baroda.
Indeed, alarm bells began ringing as early as October, when in the third quarter monetary policy review, RBI said that, “there is already some evidence of excess liquidity feeding through asset prices with potential financial stability concerns.” The Indian central bank explicitly tries to protect financial stability, besides fighting inflation and nurturing growth.
Graphic: Yogesh Kumar / Mint
“Further, capital flows have resumed. Given the limitations of the economy’s current absorptive capacity, these flows will add to the overall domestic liquidity, further fuelling the asset price build-up,” the bank added. In January, RBI again talked about the need to “strengthen the recovery process without compromising on price stability and to contain asset price inflation stemming from large capital inflows.”
With central bankers in the Western developed economies pursuing a loose monetary policy in an effort to pump up economic growth, interest rate differentials with emerging economies have widened, leading to more portfolio inflows. Foreign investors have bought Indian stocks worth some $4 billion (Rs17,760 crore) so far this year, on top of some $17 billion in 2009.
With money market funds in the US still yielding next to nothing, there is more scope for some of $2.9 trillion parked there to find its way to emerging markets, fuelling further increases in asset prices.
India is not the only emerging country which is facing the problem of managing an economic recovery while tightening interest rates and having to deal with high capital inflows. China, the only $1 trillion-plus economy in the world that is growing faster than India, has even more concerns with overheating. Its central bank is targeting a drop of 22% in new lending this year from last year’s record 9.59 trillion yuan (Rs62.18 trillion today).
“Central banks all face the pressing task of containing asset bubbles and inflation while ensuring economic recovery,” the People’s Bank of China said in its 2009 report on international financial markets, released a week ago, reopening a debate on whether central banks should target asset price inflation.
The Indian central bank has been wary of the harm that asset price bubbles can inflict on the real economy of output and jobs at a time when it was unfashionable to be so, which is one reason why it now gets admiring reviews for the deft manner in which it handled the asset price bubble that was pricked in 2008.
In 2006-07, for example, Y.V. Reddy, then RBI governor, asked banks to set aside more money as provisions against loans to the capital market and real estate.
The other side of this debate, championed by former US Federal Reserve chairman Alan Greenspan, argued that it was difficult to determine when a bubble was developing. Therefore, a central bank should act to stabilize a system only after the bubble bursts, went the argument. It cannot identify a bubble and undertake early preventive action.
The rise in commodity and asset prices to near pre-crisis levels “is certainly a cause for concern and calls for vigilance”, said Ajit Ranade, chief economist at the Aditya Birla Group. “But there is no scientific formula to say whether it’s a bubble or to determine the timing.”
“Asset prices are going up, but I think it’s not a bubble,” said Renu Kohli, an economist formerly with the International Monetary Fund and the Reserve Bank of India. She said that such bubbles are preceded by a spurt in credit growth and money supply which hasn’t happened yet in India.
Year-on-year credit growth has been recorded at around 16% the past two weeks, well off the peak levels of 27% during the pre-crisis economic boom. Money supply—measured by the so-called M3 or broad money metric—has increased at 16%.
“You should get really worried when people start consuming wealth, when they borrow against high valuations of their stocks and real estate assets,” said Jahangir Aziz, chief economist of the Indian unit of JPMorgan Chase and Co. “So far no one has started doing that.”
“There are still reasons to hold gold; it’s a hedge against inflation and a weakening dollar,” Aziz added.
However, economists such as Rege Nitsure and Ranade, who call asset bubble bursts “disruptive”, believe the central bank will look at prudential norms in the next policy review. The central bank has taken the first step as early as October when it asked banks to set aside more money for commercial real estate loans.
The main focus of the new monetary policy that will be announced next week will be the growing inflationary pressures, but RBI governor D. Subbarao will likely flag off concerns about strong capital inflows and rising asset prices, say economists.
Ashwin Ramarathinam and Harshada Karnik of Mint and Bloomberg contributed to this story.