More Pain Ahead For Indian Assets As Stagflation Risks Turn Into Reality

Indian equities and the rupee face more tough times ahead after a broad slump since the war on the edge of Europe as stagflation, which was considered a threat and a fallout of the Russia-Ukraine crisis, is fast becoming a reality.

Domestic equity benchmarks have taken a beating, tracking broader global stock markets, which have been whiplashed since Russia attacked Ukraine late in February, lockdowns in China, and fears about higher interest rates have sent a nervous jolt through financial markets.

Indian bourses lost over 2 per cent in April and have started May on a weak note. With inflation data for April due and International developments not too appealing, broad investor sentiment points to more downside.

Foreign investors have sold over Rs 6,400 crore from the Indian equity market in the first four trading sessions in May and remain net sellers for seven months to April 2022, withdrawing over Rs 1.65 lakh crore from equities.

That has weighed on the Indian currency when international crude prices have risen sharply and traded above $100 on average for the third month on supply disruptions from the Russia-Ukraine war. 

The widening trade bill as the country imports 85 per cent of its oil needs, a stronger dollar, elevated crude prices, surging inflation and expected tighter monetary policy have spooked investors.

The rupee ended close to its all-time low on Friday. The dollar scaling scaled close to its two-decade highs, gaining for a fifth consecutive week after the Federal Reserve hiked its benchmark funds rate by 50 basis points and strong jobs data there reinforced bets on further big hikes.

With the futures market pricing in a 75 per cent chance of a 75 basis points Fed lift-off in June, and over two percentage points of rate hikes this year, the dollar was expected to be well bid and weigh on most currencies.

Several Fed policymakers are scheduled to speak this week, which will give them plenty of opportunities to keep up the hawkish chorus as the Russia-Ukraine in its third month shows no signs of letting up.

That fallout from the war on Indian assets was reflected in forex reserves falling to below $600 billion for the first time since May 2021, wiping out the country's FX war chest accumulations of a year in just two months as the Reserve Bank of India has been forced to step in to shore up the rupee.

While the RBI, in an emergency meeting last week, hiked its key interest rates, runaway inflation risks are rising even as fears of a slowdown in economic growth activity persist.

"With central banks worldwide pressing the panic button and increasing interest rates, equity markets have also reciprocated the sentiment. Foreign investors continue to sell relentlessly," Vijay Singhania, Chairman at TradeSmart, told PTI.

Despite the RBI raising rates, the expected interest rate differential dynamic and flight-to-safety trades point to a gloomy mood.

"A series of rate hikes and hawkish communication came against a backdrop of plummeting Chinese and European activity, new plans for Russian energy bans and continued supply-side pressures," warned analysts at Barclays, Reuters reported.

"This creates the gloomy prospect of persistent inflation forcing central banks to hike rates despite sharply slowing growth."