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Equity outperformance raises concerns of overstretched valuations, says RBI article

economy | IST

Equity outperformance raises concerns of overstretched valuations, says RBI article


The RBI releases its impression of The State of the Economy every month in its bulletin. The November bulletin released on Monday is crucial because it is the last report before the next monetary policy on December 8.

The November bulletin of the Reserve Bank of India’s (RBI’s) monthly impression of ‘The State of the Economy’ is crucial as it is the last report before the next monetary policy announcement on December 8.

The central bank is worried about the state of the equity markets. Of course, equity markets have been the outperformers in 2021 but that has led to “overstretched valuations”, the report said. A number of global financial firms have already pointed that out.
By traditional metrics like price to book and price to equity, it is high, but RBI also uses a metric called earnings yield that tells how much one is earning for the price paid for the share. Usually, the difference between the 10-year yield and the earnings yield tends to be 1.65 percentage points, but it has now expanded to 2.47 percentage points, the RBI pointed out. This means prices have really stretched compared to historical levels and that is a worry, according to the central bank’s report.
The October consumer price index (CPI) came in at 4.5 percent. The RBI report highlights that the CPI is over and above the October 2020 inflation of 7.6 percent, which is really high. Lead indicators coming for November from the Ministry of Consumer Affairs suggest that prices of cereals have still risen in the first 10 days of November whereas tomatoes, and onions continue to rage high. It must be noted October inflation was largely vegetables-led as vegetables have risen 14 percent month-on-month, a concern pointed out in the report.
Reflecting on the money absorbing instrument variable rate reverse repo (VRRR), RBI report said in the various variable rate reverse repo auctions, the yield has systematically gone up from 3.65 in early October to 3.91 in late October and to 3.95 on November 3.
It is to be seen that since the reverse repo auctions have already pushed up the yield, will the RBI raise the reverse repo in the December 8 policy. This is a doubt that comes to people who are reading the report to market participants.
The central bank’s report ends on a positive note saying India is better off than the global economy. “We have at least a steady recovery and falling infection rate as of now, whereas the world is still beset with rising inflation, very sharp inflation in the US, and rising infections and supply disruptions. But that could also mean that global central banks could tighten faster than expected however, India is resilient,” it said.
However, this time Deputy Governor and MPC member Michael Patra who usually writes the report did not write it.
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