India’s separate asset class sentiment swings were on display in August, as foreign exchange reserves reached a record high of USD 541.4 billion to lift the rupee 2.5% for the best monthly performance on the MSCI Emerging Market Currency Index.  The stock market advanced 3.4% in dollar terms on the MSCI EM Index, narrowing its 2020 loss to 6%, as foreign investors poured USD 6 billion into local equities. In contrast, foreign investors have dumped over USD 14.6 billion of government and corporate bonds in 2020, according to Bloomberg data, with holdings at a record low of only 1.5% of the nearly USD 1 trillion local debt market subject to an aggregate quota.

Foreign outflows from the bond market come as the government plans to sell a record USD 160 billion this fiscal year which ends in March.  The total central and states fiscal deficit, long a source of investor concern as annual targets are routinely breached, is expected to spike to 11.8% of GDP as public debt/GDP rises to 86.7%, according to Fitch Ratings estimate. To spur demand for government bonds and lower the state’s borrowing costs, the Reserve Bank of India announced a new set of temporary asset allocation rules for banks. Through the end of the fiscal year banks can hold 22% of deposits in state paper, up from 19.5%, without having to report mark-to-market losses, giving them greater capacity to absorb the massive government issuance.

India has overtaken Brazil with the world’s second highest Covid-19 infection rate as the economy re-opens after the chaotic government-ordered mid-March shutdown on just a few hours’ notice which stranded millions of migrant workers. GDP in the April-June quarter – first three months of India’s fiscal year – plunged 67% from three months earlier and recorded an historic annual contraction of 23.9%. Since then manufacturing has started to rebound, with the PMI above the 50 mark which separates growth from contraction in August for the first time in months. However, the services PMI remains well below at 41.8, indicating recovery has yet to take hold in that consumer-sensitive segment. Recent foreign investor enthusiasm for Indian stocks and the rupee’s rally are unlikely to be durable against this uneven performance and predicted full fiscal year contraction of nearly 10%, but short-term spots can stand out based on other economic and prudential shifts.


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