Falling implied USD/INR vols amid rising optimism for phase-1 trade deal supportive of dollar-funded carry trade, says Scotiabank

Falling implied USD/INR vols amid increasing optimism for reaching a phase-1 trade deal between the United States and China are supportive of the dollar-funded carry trade, according to the latest research report from Scotiabank.

Continued portfolio inflows chasing Indian assets are supportive of the high-yielding INR. The current levels of NIFTY share index and 10-year India government bond yield suggest the INR is now undervalued, which could be partly explained by persistent rises in India’s foreign reserves.

In addition, further economic reforms and stimulus measures will be implemented by the Indian government. It could reinforce foreign investors’ confidence in the economy and prompt them to pour more funds into India’s equity and bond markets.

Finance Minister Nirmala Sitharaman said late Wednesday that India’s cabinet has approved a INR 100bn fund to help clear stalled housing projects to boost the real estate sector, while India’s largest lender SBI and state-run insurance company LCI will contribute an additional INR150 billion, the report added.

Earlier on Tuesday, Sitharaman also said that the government will soon use its strong electoral mandate to usher in the next wave of reforms. In the meantime, we keep a close eye on India’s fiscal slippage that is credit negative for India and has contributed to the INR’s relative underperformance versus the IDR this year.

According to Bloomberg, India’s gross and net direct tax collection grew by just 5.0 percent and 2.7 percent respectively in the April-October period, with the government staring at a revenue shortfall of over INR1 trillion.

Earlier, Fitch Solutions on Wednesday raised India's fiscal deficit forecast to 3.6 percent of the GDP for FY2019-20 from the previous estimate of 3.4 percent, Scotiabank further noted in the report.