India: Asset markets feel the jitters

Radhika Rao, India Economist, DBS Bank

Risk-aversion gripped the Indian markets on Tuesday, with the impact most stark in the debt and currency markets. 10Y government bond yields jumped to a two-year high at 7.67% vs the average of 7.5% last week and 7.3% in January (generic quote). The Indian rupee depreciated by over 1% to close at 64.79. Equities also closed in modest red.

For the debt markets, weak external trade numbers for January rekindled concerns over the economy's macro indicators. The trade deficit widened to USD16.3bn, a four-year high as exports lost momentum and a sharp jump in crude purchases buoyed imports. This added to the trickle of other unfavourable developments, including the threat of MSCI cutting India's weight in its EM basket, after local stock exchanges terminated agreements allowing their index derivatives to be traded on overseas exchanges. Concurrently, fraud investigations at a public-sector bank hurt confidence, which was earlier supported by the government's sizeable recapitalisation plan.

Domestic liquidity has turned modestly negative in midst of advance tax outflows and higher currency in circulation. The RBI has not undertaken any liquidity measures as yet, but signalled that the routine end-quarter squeeze will be smoothened. State bond auctions also attracted lukewarm bids yesterday.

Global cues have also been unfavourable, as reflation trades continue to drive US yields higher. Foreigners have trimmed their equity and debt holdings this month, likely leaving the RBI cautious at April's review of the debt investment limits.

Eyes are also on today's RBI minutes for the February meeting, with the committee's members views on the inflation outlook likely to be under close scrutiny. We expect policy rates to be held unchanged at the next policy review. Our call for shorter-term bonds on 6 February (see here) has, meanwhile, played out. Since then, 2Y INgov yields have fallen by 10 bps. Comparatively, 10Y yields have risen by 10bps over the same period. We still think shorter-tenor bonds (1Y) are relatively more attractive and elevated yields are driven largely by tight liquidity. 10Y bonds are likely to be much more volatile and we still see scope for yields to touch 7.9-8% in the coming quarters.

Source : Equity Bulls

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