India’s onshore markets are currently caught between two opposing forces: higher oil prices driven by renewed Middle East hostilities (and concern over Red Sea), and a strengthening inflows picture. A surge in benchmark crude prices pushed up USDINR, necessitating a strong intervention response from the central bank to keep the domestic currency from revisiting record lows. Long-end bond yields have, meanwhile, firmed up (but remain below 7%) on higher US rates, and soft currency price action. Yields reacted little to Finance Ministry’s comments that this year’s fiscal deficit target will not need to be revised, after indications back in June that higher oil might lead to a modest overshoot in the targets. In its latest bulletin, however, the Ministry opined that high energy prices could put pressure on financing the current account as well as fiscal deficit.
The flows picture is, meanwhile, on the mend, via a resumption in portfolio inflows into equity and debt markets as well as positive cues on the swap schemes. July saw debt markets attract more than $2bn in inflows, bringing FYTD debt inflows to $7.7bn, while equities recorded $1.5bn worth flows following consecutive months of outflows. In addition, RBI Governor Malhotra said in an interview that banks had mobilised a cumulative $32bn via the swap windows to-date, already surpassing the scale of inflows raised back in 2013. This marks ~$12bn improvement to the mid-July update. As highlighted before, we expect the scale of the FCNR(B) deposits, in particular, to pick up in second half of the scheme’s validity period, as KYC/compliance requirements are completed. Recall that ~60% of the FCNR(B) deposits were raised two months after the program was introduced back in 2013. At the current run-rate, our conservative estimate of $45-50bn of total inflows under the special schemes could be overshot. Despite the turnaround in inflows, the rupee has depreciated 1.1% this month, and a cumulative 6% on CYTD, against the dollar. The spot-neutral nature of inflows under the swap windows, increased hedging-related demand, authorities’ preference to mop-up inflows to gradually lower their exposure in the forwards book as well as a firm US dollar due to US policy tightening expectations, have constrained the room for sharp gains in the rupee. Overnight dollar pullback on Friday, will be briefly supportive of Asian currencies led by the yen, before the rupee returns to familiar play, with 95.00 to mark a floor. 
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