Money flowing into the assets of the world’s largest democracy by population, India, are showing some cracks, according to BNY Mellon chief currency strategist Simon Derrick.
Amid escalating tensions between India and Pakistan centered on the disputed Kashmir region and ahead of an election this spring, risks seem to be on the rise even though the macro impact may be limited for now, the strategist said.
On Wednesday, the longstanding conflict flared up, with Pakistan taking responsibility for shooting down a pair of Indian military jets and capturing a pilot after the planes reportedly crossed the Line of Control, dividing Indian and Pakistani-held territories for the first time since 1971 and bombed Pakistani targets. Earlier this month, a Pakistani militant group said it attacked Indian security personnel.
Fresh water-rich Kashmir in the Himalayas is jointly administered by Pakistan and India. Both nations claim Kashmir is part of their country. India and Pakistan were once united until being split in to separate nations in 1947.
“This historic conflict has been going on for several decades and a quick de-escalation should not be expected,” wrote Edward Moya, senior market analyst at Oanda.
The domestic market response, however, was one of indifference. India’s SENSEX stock index 1, -0.19% closed Wednesday’s session down 0.2%, above last week’s low, while the Indian rupee USDINR, +0.3004% was just modestly weaker against the U.S. dollar. One buck last bought 71.1504 rupees, up from 70.9967 late Tuesday in New York.
“In the case of India and Pakistan, investors are relatively accustomed to border skirmishes. Although the scale may appear more severe, this latest event draws parallels with Sep 29, 2016, when a surgical strike by India on Pakistan territory allegedly caused 35-50 casualties (which Pakistan denied). India’s stock market fell 2.1% that day and subsequently showed no further losses,” wrote strategists at UBS.
The seeming indifference in India’s markets “however, might be a little deceiving,” said BNY Mellon’s Derrick. “It’s noticeable that the SENSEX has struggled over the past four months to regain the losses it sustained between August and October of last year.”
The stock index is down 0.5% in the year so far, after gaining 5.9% in 2018, according to FactSet data. The S&P 500 index SPX, -0.07% in comparison, is up 10.4% since the start of the year.
A popular way to bet on the performance of India’s equity market, the iShares MSCI India ETF INDA, -0.72% was down 1% on Wednesday, having dropped 2.9%, thus far in 2019.
“Moreover, since mid-December our iFlow data show foreign investors have been losing faith in the local equity market while the surge of money back into the rupee since the start of November appears to have run out of steam,” Derrick said, adding that both of these facts could be illustrative of waning investor confidence in the country’s assets amid the turmoil.
No other emerging market experienced equity outflows of that magnitude coupled with petering demand for local currencies, according to Derrick. Leading the analyst to believe that dynamic reflected idiosyncratic aversion to India rather than the broader emerging market complex.
Beyond elevated martial tensions, India is heading to the polls for a general election in India this spring, which may also be fueling some uncertainty about the outlook for the country’s economy.
“With India’s national election approaching and the tight contest between Congress and [Prime Minister Narendra Modi’s] BJP, the reaction function of political leaders on both sides may increase the tail-risk related to geopolitics,” wrote currency strategists at Morgan Stanley.
Meanwhile, the Reserve Bank of India has adopted an easing bias and is facing its own problems. Last year in December, the central bank’s Gov. Urjit Patel unexpectedly resigned, which spooked market participants that saw his resignation as a blow to central bank independence. He was replaced by Shaktikanta Das, who held positions in previous governments.
Given all that the Morgan Stanley analysts continue being long the U.S. dollar versus the rupee, they said.
Meanwhile, Pakistan’s rupee USDPKR, +0.00% which is less liquid than the rupee, has been hovering near historic lows against the U.S. dollar since November last year. One dollar last bought 139.8250 rupees. Pakistan’s economy has been struggling with high inflation and a high current-account deficit, while its ailing currency reinforced those trends.
The Global X MSCI Pakistan ETF
PAK, -0.34%
was last down 0.4%, having dropped more than 3% this week so far. Since the start of the year, the ETF climbed 8.2%, retracing sharp 35% loss from last year, according to FactSet data.
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