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INR was a middle of the road performer in May, dropping 0.63% against the USD. The modest weakness was partly attributable to follow through selling from FInMin Jaitley's announcement in late April that he planned to retrospectively tax foreign institutional investors on capitalgains made in previous years. The government expects the plan to raise about USD6.5bn, providing a cushion to public finances. Some foreign funds have appealed against the ruling in the Supreme Court, the only way to overturn the decision.
In order to appease foreign investors, the Indian government has set up a panel to suggest ways to resolve the debate and some other tax issues.The RBI cut the repo rate by 25bps to 7.25%, notes RBC Capital Markets. The Statement acknowledged three risks to inflation:
- (1) a below-normal southwest monsoon which would drive up food inflation
- (2) firming crude prices
- (3) volatility in the external environment driving INR lower
RBI noted that it could have waited for more certainty surrounding the monsoon, but decided to be pro-active and front-load the rate cut in June, likely taking advantage of the recent slowing in CPI inflation (4.87%y/y in April). The Statement cast doubt on further easing this year and the risk toconsensus expectations of a further ~25bps rate cut by year end is that the RBI does not cut, which suggests limited scope for INR underperformance from lower rate expectations, says RBC Capital Markets.
