With inflation at a three-year low and a flurry of new measures to ease investment rules, now is seen as the right time for the bank to focus on pulling the economy out of its worst growth slump in a decade.
Policymakers are “clearly teed up for rate cuts,” banking on a further easing of inflation in coming quarters, lower government borrowing and more pro-market reforms, HSBC economist Leif Eskesen said.
However, those hoping the Reserve Bank of India will announce a big cut following its policy-setting meeting on Tuesday are likely to be disappointed.
The bank “is likely to tread very carefully — given lingering inflation risks,” Eskesen added.
Like other economists, he said he expected the bank to limit any rate cut to 25 basis points. The bank’s key repo rate — at which it lends to commercial banks — now stands at 8.0 percent.
Any reduction would be welcomed by Prime Minister Manmohan Singh’s scandal-scarred Congress party government, which is anxious to revive growth before facing voters in general elections due in the first half of next year.
Indian shares have been nosing higher to trade at around two-year highs in the past week on hopes of lower rates.
“The market is betting on a rate cut of 25 basis points,” said Madan Sabnavis, chief economist at Care Ratings.
Countries such as China, South Korea and Brazil have all cut rates to try to shield their economies from the spillover of the eurozone debt crisis.
But India’s central bank — which last cut rates in April after an aggressive multi-year rate-hiking spree — has resisted the clamour from business leaders and politicians for lower borrowing costs to spur the economy.
Growth fell to 5.3 percent in the July-September quarter — far below the near double-digit pace India set before the onset of the global financial crisis — while industrial output shrank by 0.1 percent in November from a year ago.
The bank has also long warned that the left-leaning government needed to curb its spending on deficit-bloating welfare programmes before interest rates could be lowered — a demand met partly by recent moves to cut some energy subsidies.
Finance Minister P. Chidambaram promised a fiscally responsible budget next month while vowing to accelerate reforms during a charm offensive last week in Asia to drum up foreign investment.
“Watch the upcoming budget closely: it will prove we mean business,” he told investors in Hong Kong, according to the Indian website Firstpost.
Indian inflation stands at 7.18 percent as it has edged down from double-digit levels in late 2011.
The central bank is expected to resist further efforts to arm-twist it into big rate cuts until it sees definite progress on reducing government borrowing and signs that inflation is clearly headed downward, economists say.
The bank “will want to keep Delhi on its toes” to ensure it pursues reforms, said Eskesen.