Widening fiscal and current account deficits, asset quality issues in banks, and political uncertainties ahead of elections along with global factors such as higher oil prices, hardening interest rates and a possibility of a trade war, are key risks for markets in the FY19.
The country is also gearing up for significant assembly elections in Karnataka, Chhattisgarh, Madhya Pradesh and Rajasthan before general elections are held.
The concern for India right now stems from political uncertainty, as political stability with a majority government after 30 years of coalition rule has helped in driving structural reforms, said Gautam Duggad, head of research at Motilal Oswal Securities Ltd. “For the reform momentum to continue, one needs political stability and that is what markets will watch out for in this busy political calendar of 2018 and 2019. Apart from this, expected earnings recovery is crucial for current valuations to sustain. Spike in crude prices could impact the macro-economic balance."
Ritesh Jain, chief investment officer at BNP Paribas Asset Management India Pvt. Ltd, lists the global risk off sentiment, strengthening dollar and higher crude oil prices as the three major concerns for the markets. “Bond yields have corrected from the top, otherwise rising bond yields was also a top concern till the government announced much lower borrowing in the new fiscal year," he said.
According to Jinesh Gopani, head of equity at Axis Asset Management Co. Ltd, the markets are expected to be volatile in FY19 due to uncertainties ahead of the elections. “More than that, the worry is on rising oil prices that will impact fiscal deficit. We do not see sharp corrections in markets now as valuations are in better territory," he added.
An increase in oil prices is likely to put pressure on fiscal and current account deficits in the year ahead as India imports majority of its oil requirement. India’s April-February fiscal deficit touched 120% of the full-year target, soaring to Rs7.15 trillion during the period due to increased expenditure and low revenue receipts. CAD in October-December also widened to 2% of the gross domestic product, driven by higher imports.
Higher minimum support prices (MSPs) announced by the government in the budget may push up food inflation. “Depending on the extent of pass-through to retail prices (to be known by the first week of June), we believe the increase in MSPs could add 40-60 basis points to headline consumer price index inflation," said UBS Securities India Pvt. Ltd.
According to Nomura, there are three main sources of vulnerability that could raise India’s risk premium: a) higher current account deficit; b) due to multiple state elections, widespread agrarian distress could push the government to announcing populist policies, fuelling inflation, fiscal slippage and a further widening of the trade deficit; c) bank asset quality, state bank fraud and sluggish pace of bad debt resolution.
“Against this backdrop, the main triggers of vulnerability are higher US rates, US dollar appreciation and G3 central bank balance-sheet reduction, which could accelerate capital outflows, raise domestic interest rates and trigger rupee depreciation—creating a vicious cycle of external funding pressures and balance-sheet stress," it said in a note on 23 March.
Trade-war concerns are under watch by global markets following the US government’s decision to impose tariffs on steel and aluminium China’s counter measures that may impact fund flows to emerging markets like India.
With the US Federal Reserve’s tightening cycle underway and the central bank’s hawkish comment, foreign fund flow to India is already considered to be at risk. In FY18, domestic institutional investors, including mutual funds and insurance companies, invested a record of Rs1.12 trillion in Indian equities, while foreign institutional investors pumped in $8.2 billion in local shares.
Radhika Rao, economist at DBS Bank, said that if risk aversion returns and dollar funding conditions tighten—fixed income of India, Indonesia, and Malaysia and exchange rate markets are likely to be the most susceptible to adjustments.
“For FY19, we expect the CAD to average 2% of GDP, with the balance pressured by firm commodity prices, higher non-oil non-gold imports as investment activity picks up pace, and domestic drags (GST, ban on letters of credit) hinder export growth. Service receipts will remain under watch as the impact of global trade protectionist policies hurt economies with surplus balances," she said in a note on 29 March.