Rate cut expected, with RBI seen staying 'accommodative'

The Reserve Bank of India is expected to cut its policy interest rate by a quarter percentage point on Tuesday, lowering it to a more than five-year low while dangling the prospect of another cut later this year if inflation trends stay benign.

Controlling inflation is the central bank's priority, but Prime Minister Narendra Modi's government would welcome any move to improve business conditions for industrialists who remain hesitant to invest, despite data depicting India as one of the world's fastest growing economies.

Most analysts polled by Reuters expect the RBI to cut the repo rate to 6.50 percent - the lowest since January 2011.

The RBI is also expected to say that it is retaining its "accommodative" stance, raising the prospect of another 25 bps rate cut later this year.

"We expect the RBI to cut the policy rate by 25 basis points and then wait, keeping the door open for more rate cuts," A. Prasanna, an economist at ICICI Securities Primary Dealership Ltd, said.

Inflation easing to 5.18 percent in February, and a government budget that kept borrowing and spending in check, has given the RBI room to make its first cut since September, resuming an easing cycle that was in full swing last year.

Bonds have rallied on these expectations.

The 10-year bond yield slumped 16 basis points in March following the government's pledge in February to stick to a fiscal deficit target of 3.5 percent of gross domestic product, and data last month showing inflation easing for the first time in seven months.

Chances for further rate cuts could rest on trends in global oil prices and the impact of the monsoon rainy season on food prices after back-to-back droughts in the two previous years.

The RBI is focussed on attaining inflation targets - aiming for around 5 percent by March 2017, and 4 percent in the medium term.

Brighter business survey

In all, the RBI reduced by repo rate by 125 bps in 2015, but it has been frustrated by commercial banks failure to pass on the full benefits to the wider economy.

Complaining of tight liquidity in the financial system, banks only passed on about half of the RBI's rate reductions to borrowers so far.

And, despite the RBI easing last year more aggressively than at any time since the 2008-2009 global financial crisis, annual economic growth slowed to 7.3 percent in the October-December quarter from 7.7 in the previous quarter.

The slowdown left the economy further adrift of the government's 8.0 percent growth target, a rate needed to generate jobs for the millions of Indians joining the workforce each year.

More positively, a business survey released on Monday showed Indian manufacturing activity expanded for the third straight month in March and at the fastest pace since July, driven by stronger demand which allowed companies to raise prices at the fastest pace in 16 months.

The latest Nikkei/Markit Manufacturing Purchasing Managers' Index showed the new orders sub-index, a proxy for domestic demand, also rose to an eight-month high, encouraging firms to increase output. Foreign demand also rose though at a slightly more moderate pace.