Indian equity markets -- is a bubble building up?

(Nipun Mehta is Executive Director & Head - India, SG Private Banking. The views expressed in this column are his own)

By Nipun Mehta

At a Sensex level of around 17,000, are the Indian equity markets looking at the face of a possible bubble in the offing? Terrifying words, probably unjustified for a market which is still 20 percent lower than its all time peak touched in Jan 2008. Let's look at it from different perspectives.

In the Indian equity markets, unlike in other global markets, it is commonly believed that the day the roadside vendor starts giving 'tips' or the day cheerleaders with pom-poms start appearing on business channels, the top is near.

This time however, we have not yet seen any of this fanfare amongst investors or business commentators. There is hence little reason to believe that a retail investor driven bubble is on the horizon. Nowhere close to it actually, since there has been very little retail or high net worth individual (HNWI) participation in the rally of the last 9 months.

What has clearly driven the markets are the Foreign Institutional Investors (FIIs) who have pumped in close to $7.4 bln in India in the last quarter raising their ownership to close to 19.2 percent up from 18.3 percent in the previous quarter. As per statistics available, FII ownership is also up by 2.5 percent from the March 2009 figure of 16.7 percent.

A large part of this is contributed by the dollar carry trade whereby FIIs raise funds at ridiculously low interest rates in dollars and invest it into a stronger currency viz INR. In the process they gain not just by the rising equity markets but also by the strengthening INR against $.

This is clearly similar to the Yen carry trade that happened earlier (whereby borrowings were in Yen at negligible interest rates) and which burst when the Yen -- a strongly controlled currency -- suddenly started strengthening. Can dollar carry trade stop? Can a similar bubble be building up in the $ carry trade as well?