The unexpected election results in India have created a degree of political uncertainty, which could impact market sentiment in the short term. However, Citi Research argues 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 focused more attention on 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 reducing volatility in these uncertain times. Citi Research continues to predict the first rate cut in October 2024, but acknowledges that future fiscal policy will need to be more proactively integrated into their framework.
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Three key factors are expected to play a role in the interest rate market:
1. Risks of fiscal slippage: Markets will be vigilant about the potential for fiscal slippage, both in the short and medium term.
2. Foreign Investor Sentiment: Political developments could prompt some foreign investors to reassess the country risk premium associated with India.
3. Interest rate policy discussions: Discussions may arise over whether the new government will support lower interest rate policies to boost growth, especially if inflation remains under control.
Currently, favorable conditions for a downward trend in bond yields have been put on hold until there is more clarity on these factors.
In the currency markets, pressure could spill over into equity markets, potentially impacting the Indian Rupee (INR). However, the RBI has significant reserves to counter any idiosyncratic depreciation pressures. Citi Research notes that it is too early for the RBI to allow a devaluation to boost government dividends. Instead, the central bank is expected to prioritize maintaining macroeconomic and financial stability, which should prevent a large, disorderly depreciation of the INR.
While the election results have created some uncertainty, Citi Research believes that 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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