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By Shamik Paul
MUMBAI, Jan 25 (Reuters) - India's central bank is expected
to reward the government next week for its efforts to reform the
economy and bring its finances under control by announcing its
first cut in interest rates in nine months.
The Reserve Bank of India (RBI) has been growing in
confidence that the government, gripped by inertia for much of
last year, is finally doing its bit to lift an economy that has
slumped to its slowest pace of growth in a decade.
"The government has gone ahead with all the promises it had
made 3 to 4 months earlier. There have been pretty substantial
measures on the fiscal deficit front," said Samiran Chakrabarty,
head of research at Standard Chartered Bank in Mumbai.
"To an extent, that will be comforting for the RBI."
Inflation is also heading in the right direction as far as
the central bank is concerned. Wholesale price inflation, the
main price gauge, fell to a three-year low of just over 7
percent in December.
Since mid December, yields on 10-year Indian government
bonds have pulled back to 7.865 percent from above 8 percent in
anticipation of a rate cut. The slide marked the first time the
yield had dropped below 8 percent since early 2011.
However, the central bank remains cautious with inflation
around 7 percent. Last week, Governor Duvvuri Subbarao said
inflation remained too high, a comment that dashed financial
market expectations for a more aggressive rate cut of 50 basis
Most economists expect the RBI to cut its policy repo rate
by 25 basis points on Tuesday to 7.75 percent and follow it up
with a cumulative 75 bps of cuts by the end of September, a
Reuters poll showed last week.
"The RBI cannot be very aggressive in rate cuts. Our view is
that inflation is unlikely to fall sustainably below 7 percent.
There are lot of suppressed inflationary pressures that will add
to it," said Sonal Varma, India economist at Nomura in Mumbai.
The RBI last cut rates in April 2012 by 50 basis points but
warned at the time there would be limited scope for further
For much of last year, the government was in turmoil as a
fractious coalition struggled to push through new policies to
arrest an economic slide that analysts forecast will leave
growth for the full-year to March 2013 at just 5.5 percent,
almost half the pace seen before the global financial crisis.
But in September it announced big bang reforms in a package
of measures to revive growth, saying it would open up its
supermarket sector to foreign chains and allow more foreign
investment in airlines and broadcasters.
More recently, it gave oil companies more room to set
regulated diesel prices and in a sign of a fresh measure that
could be in the pipeline, Finance Minister P. Chidambaram said
in TV comments aired on Thursday that India should consider
hiking taxes for the "very rich".
The moves are intended to bolster investor sentiment, mend
battered government finances and stave off a possible credit
rating downgrade to junk status.
India's fiscal deficit touched 4.13 trillion rupees ($77
billion) in April-November, or 80.4 percent of the budgeted
target for the full fiscal year through March.
The government expects a budget deficit in the current
fiscal year of 5.3 percent of GDP. Economists had pencilled in a
deficit of at least 6 percent of GDP, although they have
narrowed that to 5.5 percent or 5.6 percent of GDP following the
various government measures in recent months.
The country's current account deficit hit a record high of
5.4 percent of GDP in July-September, although Chidambaram said
the country can finance the shortfall without cutting into
Subbarao, a hawkish outlier in 2012 when many central banks
were cutting rates and putting in place other stimulus measures,
was due to meet with Chidambaram for a customary pre-policy
discussion on Thursday.
In October, the RBI gave uncharacteristically specific
guidance, saying there was a "reasonable likelihood" of policy
easing in the January-March quarter. It reiterated the same
point in December.
"The earlier guidance given by the RBI and the recent steps
taken by the government has led to the expectation of a 25 bps
rate cut," said Saugata Bhattacharya, an economist with Axis
Bank in Mumbai.
(Editing by Tony Munroe and Neil Fullick)