Rate cut hopes rise as inflation falls to 3-year low

India's headline inflation slowed to the lowest rate in more than three years in March, hardening expectations the Reserve Bank of India (RBI) will cut interest rates next month to help the economy recover from its slowest growth in a decade.

The encouraging price data was released as Finance Minister P Chidambaram began a series of roadshows in North America aimed a drawing billions of dollars of investment to Asia's ailing, third-largest economy.

Suffering from low growth and an investment drought, India needs foreign inflows to help fund a worryingly high current account deficit, while the RBI wants lower inflation to feel more comfortable about reducing interest rates that are among the highest of all the major economies.

Wholesale prices, India's key inflation measure, cooled to 5.96 per cent in March after an annual uptick to 6.84 per cent in February, the trade and industry ministry said. It was the lowest pace since November 2009 and less than forecast by a Reuters' poll of economists.

"The fact that headline inflation is below 6 per cent strengthens the case for rate cut in May," Abheek Barua, Chief Economist at HDFC bank in New Delhi, said.

Wholesale inflation has trended downward from 8 per cent in September -- good news for Prime Minister Manmohan Singh's government, which is gearing up for national elections due in early 2014.

Singh has made reviving sluggish investment and economic growth a top priority.
GDP growth hit a near four-year low of 4.5 per cent in the quarter to end-December, while growth for the fiscal year which ended last month is expected to be around 5 per cent, and the lowest in a decade.

The lower-than-expected headline inflation figure briefly buoyed stock and bond prices because of investors' view the central bank was more likely to cut the benchmark repo rate from 7.5 per cent when it next reviews policy on May 3.

But both markets stalled once realisation sank in that the January inflation figure had been revised upwards to 7.31 per cent from 6.62 per cent.

The benchmark 30-share BSE Sensex still held a 0.66 per cent gain, led by bank stocks, with State Bank of India Ltd advancing 3.3 per cent.

Reasons to be cautious

A Reuters snap survey of analysts, made after the release of the official data, showed closely watched core inflation, which strips out volatile food and fuel prices, slowed to around 3.5 per cent in March, the slowest rate in more than three years.

Analysts strongly doubted whether any rate cut by the Reserve Bank of India in May would be more than 25 basis points. While expecting the RBI to reduce rates again after next month, Barua warned that the current account deficit and high consumer prices meant there was little chance of "aggressive" cuts.

The central bank has made two 25 basis point rates cuts this year in response to cooling inflation, but is concerned that if it lowers rates too much it might undermine the rupee.

The currency is burdened by a current account gap that hit an all-time high of 6.7 per cent of GDP in the December quarter, and a weaker rupee would result in inflationary pressures from higher prices for imports.

"The RBI will be in a tough spot as the recent deterioration in the current account position warrants rates to be left high to cool the economy, though the softer inflation numbers provide a window to ease with an eye on supporting the faltering growth outlook," said Radhika Rao, an economist with DBS in Singapore.

Some economists believe India could benefit from inflows of funds unleashed by a mega-monetary easing in Japan earlier this month, but warn the net impact could be negative if yen flows push up global commodity prices or domestic demand.

"The Bank of Japan's quantitative easing will certainly have an impact on all emerging market economies including India as it will increase the flow of capital into their financial markets and create the risk of overheating, as their real sector activity is quite subdued," said Rupa Rege Nitsure, chief economist at Bank of Baroda in Mumbai.