One of India’s largest debt underwriter says the rupee, Asia’s worst-performing currency this year, is a bigger worry for the $730 billion sovereign bond market than a miss by the government on its budget deficit target.
With the US Federal Reserve expected to continue its tightening cycle and key elections due in India later this year and next, global funds may not be keen to put money to work in the nation’s assets, Shailendra Jhingan, chief executive at ICICI Securities Primary Dealership, said in an interview.
“A pick up in foreign outflows in equity and debt markets amid a strong dollar in October is a worrying sign,” he said. “A further down move in yields could accentuate these outflows, given the uncertain global environment and the Fed expected to further tighten its policy.”
A global risk aversion has seen foreigners pull $3.1 billion from local shares this month, the most since January 2008 amid the global financial crisis, and $1.5 billion from debt. Relentless withdrawals led to the rupee sinking to a record 74.4825 per dollar on Oct. 11.
While the currency has since recovered to advance in two of the past three weeks amid declines in oil prices, ING Bank NV has lowered its year-end forecast to 76.50 -- the most bearish in a Bloomberg survey -- citing political uncertainty ahead of state elections in December. The forecast compares with a survey median of 73.
Prime Minister Narendra Modi’s government is gearing up for a big test, with elections in five states over the next two months before the national vote in 2019. Some opinion polls are already predicting a win for the main opposition Congress party in the key state of Rajasthan, and a close contest in Madhya Pradesh.
Sovereign bond yields, too, have cooled 15 basis points this month after climbing to a four-year high in September, as the central bank bought debt to replenish liquidity. The drop may dull the appeal of rupee assets for foreigners, according to Jhingan.
“Lower yields could impact our ability to attract capital flows at a time when the current account deficit is expected to widen to 2.5-2.8 per cent of GDP and global interest rates led by the US are moving up,” he said.
Back home, the Reserve Bank of India may tighten policy in February when the base effect of inflation starts wearing off and more clarity emerges on the next fiscal year’s inflation path, Jhingan said. June quarter could see another hike, which would take the repo rate to 7 per cent, he said.
The RBI kept interest rates unchanged earlier this month, pausing after back-to-back hikes since June. But its intervention in the currency market in recent weeks to support the rupee has added to a seasonal cash crunch in the banking system, which could lead to a further Rs 1 trillion of debt purchases to replenish liquidity, Jhingan said.
 "Modi and rupee's fate in lockstep? $730-bn sovereign bond market is worried")
