Assembly elections in Karnataka
How are the Indian and global economic environments affecting the financial markets?
The economic environment this week is consistent with that of the past week because the same factors have carried over in combination with the release of the consumer price index (CPI) inflation data for April 2018.
- The latest CPI data points to higher inflation because of rise in energy costs. In particular, core inflation (inflation excluding the volatile food and energy components) has risen to the level of 6% year-on-year, while overall inflation has stayed between 4-5%. The current account deficit (CAD) is widening because of the rising oil price, there is pressure on the budget deficit, and the rupee is weakening, with all three of these factors also contributing to higher inflation. This could prompt the RBI to revise its inflation forecast up and possibly change its stance from neutral to tightening in the June bi-monthly monetary policy committee (MPC) meeting, especially given that the most recent meeting minutes show a hawkish bias on the part of some MPC members. If inflationary factors continue to hold sway, India may have to sacrifice some growth to hold inflation at the RBI’s medium term target of 4%.
- Elections in Karnataka have had, on net, a neutral impact on the financial markets because of the hung assembly. Though the BJP has emerged as the single largest party, the possibility of a hung parliament also emerges in the 2019 General Elections as seats won by the Indian National Congress (INC) party and the various regional parties could deprive the ruling BJP coalition of the required majority seats to form a government as has happened in
Karnataka. In 2019, the BJP could end up being the single largest party without a majority in a hung parliament. As a result, similar to Karnataka now, an unstable government could result in New Delhi in 2019, reducing the prospects of much work getting done. Such an outcome is not good for the financial markets because, in particular, foreign institutional investors (FIIs) could exit due to diminished hope for, as they have come to expect from the BJP, continued reforms and solid economic growth, putting further downward pressure on the rupee.
What to expect from the markets next week?
The Equity and commodity (other than oil) markets in India are expected to continue to be less volatile and mostly trading flat in a range-bound manner because of the absence of major triggers and the markets already building into their expectations firmer oil price and its affect on inflation. That said, possible hawkish RBI stance on monetary policy in June could act as a trigger to depress stocks and raise bond yields. The Indian rupee’s performance merits watching carefully as it is expected that the downward pressure on the currency would remain, especially dependent on the movement of the oil price (which could continue to enlarge the CAD), taking cues from US and European markets on their reaction to geopolitical factors such as Iran and Saudi Arabia’s desire to see the oil price around USD 80/barrel. Also, rising bond yields in the US could contribute to the downward pressure on the rupee because of exiting FII money, though the situation will not be as bad as the taper tantrum when the US exited quantitative easing. India has to carefully balance between the rising CAD and its foreign exchange reserves when selling US dollars to prop up the rupee.