The Reserve Bank of India (RBI) said the growth outlook and business climate have weakened but also warned of upward risks to inflation, a day before it is widely expected to keep policy interest rates on hold.
The RBI left interest rates on hold in December after raising them 13 times between March 2010 and October 2011.
Economists say it may choose to cut the cash reserve ratio (CRR), the share of deposits banks must maintain hold with the central bank, from 6 per cent, to ease tight liquidity, at its review on Tuesday.
"Upside risks to inflation persist from insufficient supply responses, exchange rate pass-through, suppressed inflation and an expansionary fiscal stance," the RBI said in its quarterly review of macroeconomic and monetary developments.
The rupee depreciated by 16 per cent against the dollar in 2011, putting upward pressure on prices of imported goods.
Annual headline inflation, as measured by the wholesale price index, slowed to a two-year low of 7.47 per cent in December. But manufactured products inflation edged up from the previous month, reinforcing expectations the RBI will leave rates on hold even though growth is slowing.
India's economy is expected to struggle to grow by about 7 per cent in the fiscal year that ends in March, far slower than the previous year's 8.5 per cent growth.
