Rupee Stress Evident, Sensex and Nifty Swing on Election

Key Takeaway

• Indian markets face downturn due to election uncertainties, with Sensex and Nifty dropping ~2% this month amid global investor caution.
• Election outcomes could swing the Sensex and Nifty significantly, with scenarios ranging from a 7% drop to a potential 3% rise.
• MSCI review may bring $2 billion in passive inflows despite foreign selling over $3.5 billion this quarter, offering some market support.

Election Uncertainty Influences Markets

The Indian stock market is currently facing a downturn, with the Sensex and Nifty indices both experiencing a decline of approximately 2% this month. This trend is largely attributed to the uncertainties surrounding the ongoing national elections and their potential impact on Prime Minister Narendra Modi's government. The anticipation of the election results, expected early next month, has led to a cautious stance among global investors. After being net buyers of over $21 billion in domestic equities last year, investors have shifted to net selling, offloading more than $2 billion this year due to the election uncertainties.

Analyzing Post-Election Market Scenarios

Market analysts have outlined three potential scenarios based on the election outcomes, each with varying impacts on the stock market:

• Scenario I: A significant loss for the Bharatiya Janata Party (BJP), winning fewer than 303 seats, could lead to a 7% drop in the Sensex and a 9% fall in the Nifty.
• Scenario II: A comfortable majority for the BJP, albeit falling short of the 400-seat target, may result in the stabilization of stocks and a potential reclaiming of their highs.
• Scenario III: Achieving near the 400-seat mark could propel the Sensex and Nifty to new records, with an expected upside of at least 3%.

These scenarios reflect the market's larger downside risk compared to the potential upside, amidst recent volatility and foreign selling.

MSCI Review and Market Prospects

The MSCI Inc.'s upcoming review could lead to approximately $2 billion in passive inflows for India, with more than 10 stocks, including Indus Towers Ltd., PB Fintech Ltd., and Phoenix Mills Ltd., potentially being added to the MSCI index. This anticipated adjustment comes at a time when the Indian stock market has seen foreign selling exceed $3.5 billion this quarter, influenced by factors such as high valuations, a resurgence in Chinese shares, and the election uncertainties. The review is expected to bolster the local stock market, despite the current challenges.

Rupee and RBI Interest Rate Outlook

The Indian rupee is showing signs of stress due to the election, as indicated by the USD/INR options curve where 1-month implied volatility is running flat with three-month maturities. This trend suggests hesitation among FX players, attributed to uncertainty about the election results. Should the final results in June be well received by asset managers, it’s likely the USD/INR curve will normalize, with short-term option volatility declining. However, a nuanced outcome may trigger a deeper inversion of the curve, impacting the outlook for RBI interest rates, which appear to be on hold for longer amid sticky inflation.