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Rupee Risks If USD Falters, Amid $20B-$25B Inflows, RBI Eyes Stability

Election uncertainties drive Indian market volatility, with potential impacts ranging from a 7% drop to new highs based on election outcomes.

By Athena Xu

5/16, 04:48 EDT
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Key Takeaway

  • Indian stock market faces volatility due to election uncertainties, with potential Sensex and Nifty swings based on election outcomes.
  • RBI's focus on building forex reserves and managing rupee stability amidst $20b-$25b expected inflows from JPMorgan index inclusion.
  • Global funds eye India's bonds, anticipating RBI rate cuts and a less hawkish stance, boosting the appeal of Indian financial assets.

Election Uncertainty and Market Impact

The Indian stock market is currently navigating through a period of volatility, attributed largely to the uncertainties surrounding the national elections. The Sensex and Nifty indices have both seen a decline of approximately 2% this month, reflecting the market's cautious stance in anticipation of the election results due early next month. This cautious approach comes after a year where investors were net buyers of over $21 billion in domestic equities, contrasting sharply with this year's shift to net selling, amounting to more than $2 billion, due to election uncertainties.

Post-Election Scenarios and Their Potential Effects

Analysts have outlined three potential outcomes of the elections, each with distinct implications for the stock market. A significant loss for the Bharatiya Janata Party (BJP) could result in a 7% drop in the Sensex and a 9% fall in the Nifty. Conversely, a comfortable majority for the BJP could stabilize stocks and potentially reclaim their highs. The most optimistic scenario, where the BJP achieves near the 400-seat mark, could propel the Sensex and Nifty to new records, with an expected upside of at least 3%. These scenarios highlight the market's sensitivity to political developments, with a larger downside risk compared to potential upside amidst recent volatility and foreign selling.

RBI's Role in Managing Economic Stability

The Reserve Bank of India (RBI) is playing a crucial role in managing economic stability during this period of uncertainty. The RBI's interest in building foreign exchange reserves as a defense against volatility is evident, with Governor Shaktikanta Das emphasizing the importance of these reserves. The central bank is expected to mop up dollar inflows from the passive flows resulting from JPMorgan’s inclusion of India into its indexes, which is likely to bring $20b-$25b of inflows over 10 months. This action is aimed at curbing any sharp appreciation of the rupee, which has been the worst performer in Asia so far this month, despite a weaker dollar.

Global Interest in Indian Bonds and Economic Outlook

Global funds are increasingly focusing on India's longer-maturity bonds, betting on the RBI's future less hawkish stance and the anticipated inclusion of these bonds in JPMorgan Chase & Co. indexes. This shift is driven by expectations of RBI rate cuts between October and December, aligning with inflation targets. The anticipated $40 billion inflows from the index inclusion highlight the growing appeal of Indian securities to global investors. The government and RBI's supportive measures, including reforms, fiscal discipline, and strategic interventions to maintain currency stability, have bolstered the resilience and attractiveness of Indian financial assets.

Management Quotes

  • Shaktikanta Das, RBI Governor:

    "RBI Governor Shaktikanta Das has been vocal on building FX reserves to guard against risk-off episodes."

  • Anup Roy (citing people familiar with the central bank’s thinking):

    "FX reserves will remain the first line of defense against any volatility induced by index inclusion inflows... The RBI may consider tweaking its liquidity framework in future to include foreign exchange intervention as an official tool if large flows become persistent."