22/08/2016 8:19 AM IST | Updated 22/08/2016 8:26 AM IST

Urjit Patel Faces Nervous Markets After Rajan Rally

The currency fell 0.4 percent on Friday.

Danish Siddiqui / Reuters

Investors in Indian markets have a recent rally in bonds and stocks to thank for any nervousness Urjit Patel's appointment as central bank boss is causing.

Benchmark 10-year bond yields dropped to a seven-year low and the S&P BSE Sensex has surged 5 percent since current governor Raghuram Rajan announced on June 18 that he won't seek another term. Rupee forwards advanced 0.1 percent as of 8:21 a.m. in Singapore on Monday, after Patel's appointment was announced Saturday. The currency fell 0.4 percent on Friday.

Bonds and equities advanced in recent weeks on the back of surging global liquidity and amid speculation the next governor would be more willing than Rajan to lower policy rates and would be less stringent in enforcing reviews of bank assets. On the first count, Patel's role in pushing through the adoption of India's inflation target aligns him with Rajan. On the second, the new governor hasn't expressed any strong views. He will probably continue in the footsteps of his predecessor, Nomura Holdings Inc. wrote in an Aug. 21 report.

"Bond yields may rise as he is hawkish on inflation," said Sanjiv Bhasin, executive vice president at India Infoline Ltd., a Mumbai-based brokerage. Markets have become "extremely frothy" and "valuations look overstretched," he said, predicting a decline in equities over the next few weeks.

India is among the emerging markets benefiting from fund inflows after global central banks continued to boost stimulus. Leaving aside speculation on who will be the next governor, positives have come in the shape of above-average rainfall that's supportive of company earnings and Prime Minister Narendra Modi's success in getting lawmaker approval for the creation of nationwide sales tax, his biggest legislative win during two years in office.

Bond Bulls Have Most at Stake as India Gets New Central Banker

The choice of Patel as Rajan's successor was a bit disappointing, said Nikhil Bhatnagar, a New York-based senior vice president for Asian equities at Auerbach Grayson & Co., a brokerage specializing in global trading. He has previously said that he hoped the government would choose a " pro-growth governor."

"While Mr. Patel is well accomplished, I wonder if it will be a continuation of Rajan's policies," he said. "India desperately needs to ensure that monetary policy moves in tandem with fiscal policy over the next five years."

Investors Piled In

Overseas investors piled $2.7 billion into stocks and rupee-denominated debt last month, helping the Indian currency climb 0.8 percent in its first monthly gain since March. They have been net buyers of local shares for 28 days in a row, the longest stretch since the 31 days through Nov. 20, 2013. Foreigners bought a net $38 million of equities on Aug. 18, taking this year's inflows to $5.8 billion, the most in Asia after Taiwan and South Korea.

The rupee closed at 67.06 per dollar on Friday, down 0.3 percent on the week. One-month non-deliverable forwards were at 67.38 per dollar on Monday, after strengthening as much as 0.4 percent to 67.19.

The S&P BSE Sensex has rallied 22 percent from a bear market reached in February. The gauge is valued at 16.3 times projected 12-month earnings, near the highest since April 2015. The MSCI Emerging Markets Index is valued at a multiple of 12.6.

Indian Rallies

"Foreign inflow in emerging markets will determine the move of Indian stocks from here," Dilip Bhat, joint managing director at Mumbai-based Prabhudas Lilladher Pvt, said by phone. "Every correction, even if healthy, will be a buy on dip."

Government bonds joined a global debt rally in July as the good monsoon and improving domestic liquidity also spurred demand.

Foreign holdings of local-currency notes jumped by 69.54 billion rupees ($1 billion) last month, the most in nine months. India's 10-year yield is the highest among major Asian markets despite falling seven basis points this month and 28 basis points in July in what was the largest such drop since May 2013. Its close of 7.08 percent on Aug. 11 was the lowest since Sept. 2009, data compiled by Bloomberg show.

The rally took a breather last week as surging inflation weakened the outlook for interest-rate cuts. Sovereign notes under Rajan offered an annualized total return of 12.5 percent compared to 8.3 percent during his predecessor, Duvvuri Subbarao's term, Bank of America data show.

"On the bond side we have seen a very decent rally and a couple of factors -- like oil prices and the inflation trajectory, the incremental gains in bonds may be limited," said Navneet Munot, who oversees $18 billion in assets as chief investment officer at SBI Funds Management Ltd., in a phone interview. "Globally bonds yields are likely to have bottomed out and are likely to inch up, which will also impact the Indian markets."