India's headline inflation eased marginally in March helped by a softening in prices of manufactured goods, reinforcing expectations the Reserve Bank of India (RBI) will cut interest rate for the first time in three years on Tuesday to revive economic growth.

The wholesale price index (WPI), India's main inflation indicator, rose an annual 6.89 per cent in March, higher than 6.70 per cent rise estimated by analysts. Wholesale prices rose 6.95 per cent in February.

The annual reading for January was revised up to 6.89 per cent from 6.55 per cent, the government said in a release on Monday.

The central bank's nearly two-year long battle against high inflation, coupled with a political logjam in New Delhi and an uncertain global economy, has slowed down India's economic growth. The growth probably faltered to a three-year low of 6.9 per cent in the 2011/12 fiscal year that ended on March 31.

"For the RBI (Reserve Bank of India) what should really matter is the manufacturing number as policy rates act on the demand side, so we think the RBI will cut rates," said A. Prasanna, an economist at ICICI Securities Primary Dealership.

The RBI is widely expected to cut its main lending rate - the repo rate - by 25 basis points to 8.25 per cent when it reviews policy on Tuesday.

The central bank has already cut the banks' cash reserve ratio, the amount banks must maintain with the central bank in cash, by 125 basis points in two moves since late January to 4.75 per cent, making more money available for lending.

Manufacturing goods inflation - a barometer for demand-driven price pressures - dropped to 4.87 per cent from 5.75 per cent in February.

Financial markets, which are betting on a rate cut on Tuesday, shrugged off the data.

However, a spike in food prices and suppressed fuel inflation are likely to temper the quantum of rate cuts for the year. Food prices rose 9.94 per cent on year in March compared with a 6.07 per cent rise in the previous month, while fuel inflation eased to 10.41 per cent from 12.83 per cent in February.

"In the coming months, primary and fuel inflation will continue to inch higher, because of seasonality and in fuel because of incomplete adjustment in prices," said Shubhada Rao, chief economist at YES Bank.

Risks Ahead

Domestic political compulsions have helped in keeping fuel inflation largely steady. Global oil prices have been on the boil on rising geo-political tensions despite the prospect of cooling demand in a slowing global economy.

India's heavy dependence on imported crude makes it vulnerable to the vagaries of the oil market. Even as a soaring fuel subsidy bill is bleeding its finances, political compulsions have desisted the government from raising pump prices.

New Delhi risks a further erosion of fiscal credibility if it continues to delay a decision on raising fuel prices. But any increase in prices could accelerate inflation, which in turn could have a bearing on the central bank's monetary policy.

"We remain slightly hesitant of calling for aggressive rate movements by the RBI and the incremental pace of change will depend on the inflationary dynamics," said Indranil Pan, chief economist at Kotak Mahindra Bank, who expects a 25 basis points rate cut on Tuesday.

Monsoon rains, critical for India's farm sector, have the potential of upsetting all inflation projections. Normal rains this summer should help rein in food prices.

Failure of monsoon rains in 2009 resulted in India's one-and-a-half year of struggle with high food inflation.

New Delhi's move to raise indirect tax rates last month to shore up its finances is also likely to push up prices in the near-to-medium term.

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