CONCLUSION: We are suspending our bearish bias on rupee-denominated assets – particularly Indian equities – on the event that INR-supportive inflows pick up in the immediate-term ahead of a potential rate cut. Further, higher lows in the rupee has the potential to develop into a sustainable TREND, making the risk/reward on shorting India from here a lot less asymmetric than it has been recently.
Over the weekend, RBI Deputy Governor Subir Gokarn explicitly confirmed a shift in the central bank’s policy bias to growth-supportive, rather than constrained by ever-present inflationary pressures stemming from infrastructure bottlenecks, elevated food and energy prices, and, of course, the central government’s bloated fiscal budget.
Into and through the event, India’s interest rate swaps market went from pricing in no monetary policy changes over the NTM (a core component of our bearish thesis) to pricing in -39bbps of easing, suggesting to us that the market has taken this rhetorical shift quite literally.
International inflows to India’s INR-denominated debt market are picking up as well, as Global Macro investors attempt to get ahead of pending rate cuts, etc. India’s 10yr sovereign debt yields have declined -30bps over the past month, 19bps of which occurred in the past week.
Indian equities, still decidedly in a Bullish Formation, flashed a critical positive divergence overnight, closing up +15bps with most of the other major markets in the region down 2-4% on the day. If the tide on Global Macro sentiment turns in the coming weeks – particularly on the heels of politicized action out of the Fed or ECB – India could potentially test its TRADE and potential TREND lines of resistance. Importantly, this would coincide with the RBI lowering rates by 25-50bps at its JUN 18 meeting.
Our proprietary G/I/P analysis suggests that it would be imprudent to for the RBI to streamline the current disinflationary forces they point to as supportive of adopting an easing bias. In fact, our models point to limited downside in Indian inflation over the intermediate term, a finding supported by the recent peaking of the disinflationary tailwind that is Deflating the Inflation (commodities) due to measured weakness in the rupee (-12.3% vs. the USD from its YTD peak).
To the RBI’s credit, however, the decline in crude oil prices does reduce inflationary pressure stemming from the fiscal deficit, as it allows the gov’t to reduce subsidy expenditures on capping gasoline and diesel prices.
Net-net-net, with the RBI now shifting to a growth-supportive policy stance, you could actually see capital inflows accelerate in the short term (positive for the INR vs. the USD); whether or not this becomes a sustainable trend remains the key question – we’ll let the market tell us what to do here. We’ve said all along that Deflating the Inflation would be a bullish factor for the global economy (India included), but also that getting from point A to point B required short-term pain from a financial market perspective. India, which was one of the first major equity markets to start breaking down in the YTD, may indeed signaling to us that “point B” has gotten incrementally closer from a domestic perspective.
All told, we would be reckless to fight the whims of Indian policymakers, who are eschewing vigilance on inflation (currently 270bps above their unofficial target) in favor of adopting a growth-supportive monetary policy bias. As such, we are suspending our bearish bias on rupee-denominated assets – particularly Indian equities – on the event that INR-supportive inflows pick up in the immediate-term ahead of a potential rate cut.