The Hindu Business Line : FII demand putting pressure on equity valuations: RBI

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FII demand putting pressure on equity valuations: RBI

‘Levels not backed up by business fundamentals’

Beeline to market
Sensex increase fuelled mainly by FII investments.
Net investments by FII this year up to Oct 2007 at $15 b.
Bank stocks continued to outperform the Sensex.

Our Bureau

Mumbai, Nov. 27 Huge demand from foreign institutional investors has pushed up valuation of Indian equities at levels not backed up by business fundamentals.

This appears to be the view of the Reserve Bank of India on the recent rally in stock prices.

“Although the macroeconomic fundamentals are strong as also the corporate earnings, large demand by FIIs, given the limited supply of domestic assets, is putting pressure on the equity valuations,” RBI said in its latest report on Trend and Progress in Banking in India, released on Tuesday.

The price earnings (PE) ratio of BSE Sensex stocks, which was 18.6 in February 2006, rose to 22.6 by end-September 2007. In the current year, the benchmark Sensex increased by 48.4 per cent over March 2007 and 74.6 per cent over end March 2006. The rally has been fuelled mainly by FII investments, the report said.

Net investments by FII this year up to October 19, 2007 were $15 billion, which is 163 per cent higher than that during the whole of 2005-06.

Bank stocks

The bank stocks continued to outperform the Sensex, BSE-500 and most of the sectoral indices with the exception of PSUs and capital goods sector during the current financial year, the report said.

Apart from favourable macroeconomic fundamentals, bank stocks were driven by some sector-specific developments such as the financial performance by PSUs and private banks and the passing of the SBI Amendment Bill, paving the way for its subsidiaries to list on stock exchanges.

Although banking stocks outperformed the market, they also showed significantly higher volatility in 2006-07. However, the volatility did not worsen in the current financial year.

Equity market risk

The report said that as far as banks in India are concerned, the equity market risk could be moderate as they have limited exposure to the equity markets. However, sharp adjustment in the real estate prices might have some implications for the balance sheet of banks, though there has been a deceleration in their exposure to this sector.

Referring to the recent global developments that led to the imbalances in the financial markets, the report said that apart from the credit and market risks, banks now need to manage the liquidity risk more carefully. This is one of the risks ignored even by the Basel-II framework.