Rupee at 80, 10-year IGB at 8%: The five bearish forecasts from UBS

The selloff in the Indian market is showing no signs of easing with the Nifty on Thursday dropping to its lowest level in more than a year following the US Federal Reserve’s decision to hike policy rates by 75 basis points (bps), steepest since 1994. UBS has issued a note in which it has several red flags for the Indian market. Here are five of them that should prompt investors thread with caution:

INR at 80 v USD

UBS Emerging Market (EM) strategist expects the INR to weaken to 80 against the USD in the next three months, with risks skewed to the upside. “Our bearish view on the rupee is a reflection of: a) the deteriorating current account deficit; b) rich Nifty valuations' impact on equity outflows; and c) very low risk premia in USD:INR derivatives vis-à-vis the rest of the EM.”

10-year IGB at 8%

The brokerage sees the yield on the 10-year India government bond (IGB) topping the 8 per cent mark before the end of the fiscal. “We expect India's consolidated fiscal deficit to remain elevated at 10.2% of GDP (central government: 6.7%, states: 3.5%) in FY23. This would keep government borrowings elevated and pressure bond yields. We retain our 10y IGB yield target of 8%.”

Repo rate at 6.25%

Earlier this month, the Monetary Policy Committee (MPC) of the Reserve Bank of India raised the repo rate by 50 basis points to 4.90 per cent to curb elevated inflation levels. UBS believes the RBI is far from done. “The general expectation was that the MPC will need to raise policy rates well above consensus estimates (market pricing in a repo rate of above 7%) taking into account the hawkish Fed and elevated global crude oil prices. Taking into account the recent turn of events, we now expect the MPC to hike the repo rate to 6.25% by end-FY23.” UBS met over 50 domestic as well as foreign investors over the past month. Most of them believe coordinated action between monetary and fiscal authorities over the past month to control rising inflation was a step in the right direction.

ALSO READ - How a weaker rupee will impact the Indian economy and people?

No quick reversal in FPI flows

The selling by foreign portfolio investors have exceeded Rs 2 trillion ($25 billion) this year. This is the steepest selloff in absolute terms for any year and second-worst after the 2008 Global Financial Crisis if one looks at it relative to FPI assets under custody (AUC). While FPI selling could slow going ahead. We won’t see a reversal in a hurry. “Recent de-rating has pushed the Nifty 12-month forward P/E down to its five-year average. However, India remains expensive relative to EM. Therefore, while we believe the likelihood of FII selling is low, we are not confident of a quick reversal in FII flows. We are underweight on India relative to EM and our Nifty year-end target is 16,000.”

Moderation in domestic flows

India markets have been able to digest such a large selling by FPIs thanks to domestic investor flows. However, the rise in fixed-income rates coupled with the spike in volatility in equities, domestic investors could shift their preferences, weighing on domestic inflows. “The impact of FPI outflows has been more than offset by record retail inflows (direct + mutual funds). However, we expect household flows into the market to soften with the reopening of the economy and avenues for consumption. Household asset allocation decisions towards equities have a high dependence on bank deposit rates. As bank rates rise, we expect household flows to slow.”