Election Fallout: Citi Research on India's Rates and FX

The unexpected election results in India have introduced a degree of political uncertainty, which could influence market sentiment in the short term. However, Citi Research maintains that this development is not significant enough to warrant immediate changes to their macroeconomic forecasts for growth and inflation.

The Reserve Bank of India's (RBI) Monetary Policy Committee (MPC) meeting on June 7 paid closer attention to the fiscal implications of the upcoming budget. In light of this, the RBI has maintained the status quo in its June 2021 policy to focus on mitigating volatility during these uncertain times. Citi Research continues to project the first rate cut in October 2024 but recognizes that future fiscal policy will need to be integrated more proactively into their framework.

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For the rates market, three key factors are anticipated to come into play:

1. Fiscal Slippage Risks: Markets will be vigilant about the potential for fiscal slippage, both in the short and medium term.

2. Foreign Investor Sentiment: Political developments might prompt some foreign investors to reassess the country risk premium associated with India.

3. Interest Rate Policy Discussions: There may be discussions about whether the new government will support a lower interest rate policy to boost growth, especially if inflation remains under control.

Currently, the favorable conditions for a downward trend in bond yields have paused until there is more clarity on these factors.

In the currency markets, the equity market pressures could spill over, potentially impacting the Indian Rupee (INR). However, the RBI has significant reserves to counteract any idiosyncratic depreciation pressures. Citi Research notes that it is too early for the RBI to allow a depreciation bias to boost government dividends. Instead, the central bank is expected to prioritize maintaining macroeconomic and financial stability, which should prevent any large, disorderly depreciation of the INR.

While the election results have introduced some uncertainty, Citi Research believes that the broader macroeconomic forecasts remain unchanged for now. The RBI has also maintained a cautious approach, focusing on stability as it navigates these developments.

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