Indian Rupee - Forex Update

The Reserve Bank of India raised interest rates by 25bp to 6.00% yesterday, ignoring 11th-hour dovish comments by government officials and generally in line with the market's expectations. There were worries, following comments from Fin Min Chidambaram that inflation expectation is already under control that the government could have pressured the central bank to not hike despite the rather elevated inflation numbers. The move we think would have reduced the risks of the central bank falling behind the curve in handling inflation rate. The overall tone of the policy statement is considerably hawkish and, our economist believe, does not indicate an exit from the tightening cycle. The RBI has stressed that the policy stance would be to maintain inflation in the 5%-5.5% band and growth considerations should not take precedence over price stability. The RBI identified strong demand condition and the significant misalignment of domestic fuel prices with global prices due to subsidies as key risks. It also appears that the RBI's concern over the strength of domestic demand will only ease when credit growth starts to move into its comfort level of 20% a year. At this stage there are as yet no real indicators to point to easing inflationary pressure, both from the demand- and supply-side factors. With the Fed likely to pause at 5.5%, the India's rate premium over the US is likely to remain at least 50bps or higher. We expect the authorities to keep the USDINR below the 47.00 mark though the downside may also be similarly limited given the government's recent eagerness to slow down the INR strength at any level. We reiterate our 1-month INR forecast of 46.50.