India's headline inflation slowed to its lowest level in more than two years in January as food prices fell, increasing the pressure on the RBI to cut rates to battle the country's economic slowdown.
The wholesale price index, India's main gauge of inflation, rose 6.55 percent from a year earlier, its slowest rise since November 2009, broadly in line with the 6.60 percent average forecast in a Reuters poll, after a rise of 7.47 percent in December.
Slowing inflation is good news for Indian policymakers, who have been struggling for two years to rein in prices.
"The manufacturing and core manufacturing inflation have slowed down more than expected," said A. Prasanna, an economist at ICICI Securities Primary Dealership in Mumbai, who expects headline inflation to ease to 6.25-6.50 percent in March.
"This has raised chances of a 25-basis point rate cut in March (rather) than in April. The rupee's rebound in January has also partially helped inflation to ease."
The Reserve Bank of India is widely expected to start cutting interest rates in the quarter beginning April 1, as it looks to stimulate an economy that is headed for its slowest growth in three years. The central bank had a 20-month tightening cycle that ended in October.
Economists expect the RBI to cut its policy rate by 100 basis points from the current 8.5 percent in 2012, with a cut of 50 basis points in the April-June quarter.
India's federal bond yields and swap rates fell after the data. The benchmark 8.79 percent, 2021 bond yield fell 2 basis points to 8.18 percent.
The benchmark 5-year swap rate fell 3 basis points to 7.28 percent and the 1-year swap rate dropped 5 basis points to 8.04 percent.
Annual food prices in January fell 0.52 percent from 0.74 percent rise in December, helped by improved supplies of vegetables.
However, prices of protein-rich food items such as eggs, fish and meat, milk and pulses remained high, suggesting that food inflation remains a potential problem area.
Manufacturing inflation, a barometer for demand-driven price pressures, dropped to 6.49 percent from 7.41 percent in December.
Fuel prices rose 14.21 percent from a year earlier, compared with an annual rise of 14.91 percent in December.
Fuel inflation has been steady, as political considerations have forced the government to delay an adjustment in petroleum and coal prices.
Any government move to align domestic petroleum prices with global prices to reduce its massive subsidy bill runs the risk of igniting inflation.
A decision on petroleum subsidy reforms is expected after the conclusion of a series of state elections being held between now and early-March.
In keeping its policy rate unchanged last month, the RBI cited risks to inflation from global crude oil prices and the weak rupee, as well as India's yawning fiscal deficit.
The rupee fell nearly 16 percent last year against the dollar, before rebounding somewhat this year.
The fiscal deficit, however, is widely expected to be almost a percentage point higher than the government's target of 4.6 percent of gross domestic product for the fiscal year ending March 31, largely reflecting a slowdown in economic growth.
The government said last week that it expects the economy to grow 6.9 percent in the current fiscal year, the slowest growth in three years.
Policymakers have blamed the euro crisis and high interest rates for the loss of growth momentum, but analysts also point the finger at the government's own policy paralysis as a major factor in discouraging investment.