On Monday, the benchmark Sensex gave up most of the day’s gains to eventually settle 0.4% up. Some other equity markets in the world had bigger bounces (see chart), suggesting that one needn’t attach much significance to India’s performance. The rupee closed 0.28% down while the 10-year bond yield ended at 7.181%, compared to its previous close of 7.134%.
Last year’s demonetisation and the goods and services tax implementation in July had somewhat dampened sentiment for the Bharatiya Janata Party (BJP) government. In that backdrop, the Gujarat polls were closely watched, considering it is also Prime Minister Narendra Modi’s home state. However, the neck-and-neck fight between the BJP and the opposition, and then the BJP falling short of its 2012 tally of 115 seats may have hurt sentiment towards the end of the day.
The rupee reversed from the day’s low as soon as signs emerged that the BJP will win a closely fought race, said Sugandha Sachdeva, vice-president (metals, energy and currency research) at Religare Securities Ltd.
With the Gujarat polls out of the way, what is the outlook?
Kotak Institutional Equities thinks the market’s focus will increasingly shift to the macroeconomy and corporate earnings. Lately, India’s macro has been on shaky ground what with rising inflation, increasing crude oil prices and rising bond yields. “The equity market seems to be much more sanguine about India’s macro than the bond market," wrote analysts from Kotak in a report on 14 December.
“We note that India will have to likely contend with a weaker macro in CY2018/FY2019 versus CY2017/FY2018 given likely higher inflation/interest rates and possibly higher CAD/weaker currency," they added. CAD is current account deficit.
For the rupee, in the near term, the BJP’s victory in Gujarat elections will keep sentiments positive and it is likely to appreciate towards the 63.80 mark, said Religare’s Sachdeva. “However, the optimism that the tax reform bill will be passed in the US this week leading to a stronger US dollar index, and inflation as well as fiscal slippage concerns back home could weigh on the rupee thereafter," she added.
As for bonds, traders feel that given the BJP’s modest victory, the probability of the government abandoning fiscal frugality in the coming Union budget is high. A further widening of the fiscal deficit would queer the pitch for inflation as well as mean higher bond supply. This means that the 10-year bond yield could rise in the coming days in anticipation of this fiscal slippage.
That’s not all. With many state elections lined up, uncertainty is likely to increase. Understandably, many expect shades of populism to emerge in the run-up to the next general election (2019). These factors, along with the macro worries, should bring in more volatility in sentiment in the coming days.