RBI seen cutting interest rates as growth stumbles

However, recent uptick in WPI, CPI and record-high current account deficit seen limiting space for aggressive monetary easing

The Reserve Bank of India (RBI) is expected to cut its key policy rate on Tuesday for the second time in 2013 to help revive a faltering economy, taking comfort from moderating core price pressures and the government's commitment to trim the fiscal deficit.

The RBI reduced the repo rate by 25 basis points to 7.75% in January after holding it steady for nine months, and a recent Reuters poll forecast a further 25 bps cut.

However, a recent uptick in headline wholesale inflation, rising food price-driven consumer inflation and a record-high current account deficit are seen limiting the RBI's space for more aggressive monetary easing.

Central bank watchers expect Governor Duvvuri Subbarao to maintain a guarded stance on future rate cuts.

"I think the RBI will be very careful that expectations don't build up of aggressive easing, going forward, because of concerns over CPI, the current account deficit, so in that sense it will be hawkish," said Abheek Barua, chief economist at HDFC Bank.

India's economy is on track to grow at its slowest in a decade at around 5% in the fiscal year ending this month, and is expected to see modest improvement in the following year.

Price Pressures

The current account deficit hit a record-high 5.4% in the September quarter and is expected to end the 2012/13 fiscal year at its highest level ever.

February's wholesale price index rose an annual 6.84%, faster than in January, although non-food manufacturing inflation, which the central bank uses to assess demand-driven price pressures, slowed to 3.8%, the weakest pace since March 2010.

Rate cut expectations also strengthened after Subbarao said last week that the federal budget for 2013/14 will have a "softening impact" on inflation.

In the federal budget announced at the end of February, Finance Minister P Chidambaram said fiscal deficit would fall to 5.2% of GDP in the current fiscal year and 4.8% in the next year, targets intended to help stave off a sovereign credit rating downgrade to "junk" status.