There is bubble beyond financing

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Financial markets have several times in the past witnessed asset bubbles. These have been led by speculative demand for the asset and cheap financing. But ironically the demand side of the bubble very often overshadows the supply side of it. And if this is ignored, it often gets too late to avoid the bubble burst. What we are referring to is the situation of 'over capacity'.

In industrial jargon, the situation of 'over capacity' could be conceived as benign. As this means that the firm has sufficient capacity to cater to incremental demand. This also means that the company will be able to grow sales and profits without spending more on capacity. This indeed could be the case, unless the over capacity is excessive. That is if all firms expecting a surge in demand build up so much capacity that ultimately none are able to utilize it to the optimum levels. What then follow are price cuts and stiff competition to stay in business. These could ruin the business' profitability.

Unfortunately a similar kind of situation seems to be in the fray in developing economies like India and China. Increasing per capita income and high savings rate are expected to boost consumption in the world's two most populous countries. Everybody from car and clothing manufacturers to cement and steel manufacturers are lining up capacities. But the number of buyers for the same are falling short.

As per KPMG, India recorded sales of 2.5 m vehicles in FY10. This seemed excessive for a country where just 12 people in 1,000 own a car or utility vehicle. While the demand may sustain for few more years, the capacity build up is unlikely to be well utilized. In fact nearly a third of vehicle manufacturers have predicted that India would be struggling with overcapacity in the auto sector within the next five years.

The situation is not very different for the cement and construction sectors. Cement players are already facing pricing pressure as the excess capacity is already on stream. In fact demand in urban markets are so poor that companies are drawing have aggressive plans to tap rural markets.

Real estate players may want to hold lofty prices for long. But if they do so even India may end up with an alarming inventory of unsold homes and offices. China for example currently has 65 m housing units waiting to be sold. The Indian Express recently reported 96.3 m sq. ft of residential area being unsold in Mumbai at the end of June 2010. This was nearly twice of what it was two years ago.

Thus the situation is very disturbing to say the least. It is best that such indicators are not ignored so that we are too late to stop the bubble from bursting.