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December inflation at 7.18 percent, slows to three-year low

December inflation at 7.18 percent, slows to three-year low

India's headline inflation slowed down to its lowest level in three years, hardening expectations for an interest rate cut by the Reserve Bank of India (RBI) later this month to boost an economy that is set to post its slowest growth in a decade.

The wholesale price index (WPI), India's main inflation indicator, rose an annual 7.18 percent in December, the slowest since December 2009 and lower than 7.4 percent rise estimated by analysts. Wholesale prices rose 7.24 percent in November.

The slowdown in the headline number was led by a moderation in the prices of fuel and manufactured goods. The annual reading for October was revised down to 7.32 percent from 7.45 percent, the government said in a release on Monday.

"The most pleasing component is that for manufactured goods, which account for the bulk of the WPI and is probably the closest thing that India has to a core measure of inflation. This gauge has been trending steadily lower for several months now and could go lower in the coming months. The fall was broad-based, with most subcategories of manufactured goods showing lower inflation in December, suggesting that it is being driven by supply-demand dynamics. That is, the Indian economy has been growing below potential for several quarters and this is now driving inflation lower," Moody's Analytics said. 

"These signs all suggest that manufactured goods inflation will trend lower in the coming months, which will probably be enough to drag headline WPI slightly lower. We are likely to see WPI inflation trend below 7 percent in the second quarter of 2013." (More expert views)

"Based on this data, we expect the RBI (Reserve bank of India) to cut rates by 25 basis points," said A. Prasanna, economist at ICICI Securities, Primary Dealership, in Mumbai.

The RBI's next policy review is on January 29, when it is widely expected to cut the policy repo rate, which has remained unchanged at 8.0 percent since April 2011, by at least 25 basis points.

The RBI said last month that it expects the inflation numbers to edge up in December and January before moderating.

However, the WPI numbers may not cool as much as expected after January if the government implements a proposal to raise diesel prices every month by one rupee per litre.

New Delhi is trying to mend its finances as the end of the fiscal year in March nears, by raising railway passenger fares and subsidised fuel prices to reach its fiscal deficit target of 5.3 percent of GDP.

Asia's third-largest economy is likely to post its slowest growth in a decade this fiscal year after investment sentiment was hit by sluggish policymaking, a swelling fiscal deficit, high inflation and elevated interest rates. India is likely to post a growth of 5.5-5.6 percent in 2012/13.

Industrial output contracted 0.1 percent in November on weak capital goods production and muted consumer demand.

The RBI, in recent years one of the most hawkish central banks globally, was unable to shift its policy stance towards growth until December due to stubborn inflation, even as its peers in China, Brazil and South Korea became more aggressive on policy easing to support growth.

In an anticipation of an interest rate cut, financial markets rallied after the data. India's 10-year bond yield fell to its lowest in 29 months, while the rupee strengthened against the dollar.

The rupee strengthened to as much as 54.61 per dollar from around 54.70 and was trading at 54.63/64.

The 1-year overnight index swap rate fell around 2 bps to 7.51 percent, while the 5-year swap rate fell around 2 bps to 7.17 percent, according to traders.

Economic growth that once looked poised to hit double-digits has been stuck below 6 percent for the past three quarters, hurt by a combination of weak investments and consumer demand.

The slowdown has constrained job opportunities for a bulging young population, a worry for the Congress-led ruling alliance as it prepares for a series of state elections and a general election due in 2014.

It has also buffeted government revenues, swollen the fiscal deficit and put the country's investment-grade sovereign credit rating on the line.

With inputs from Reuters