The Reserve Bank of India may cut its key policy rate on Tuesday after a nine-month hiatus, drawing comfort from the abating inflation in the October-December quarter.

Further, core inflation pressures have receded and are unlikely to re-emerge quickly on demand considerations, the RBI said in its Macroeconomic and Monetary Developments document, released on the eve of the third quarter review of the monetary policy.

Core inflation is a measure of price rise that excludes items with volatile price movements such as food and energy.

Fiscal risks diminish

The case for a rate cut could also be strengthened by the fact that on the fiscal side, near-term risks have diminished. This is due to the Government’s commitment to stick to the revised fiscal deficit target of 5.3 per cent of gross domestic product.

Bankers and economist expect the central bank to pare the repo rate by at least 25 basis points.

Rate cut demand

The RBI had last cut the repo rate (the interest rate at which banks draw overnight funds from the central bank to tide over temporary liquidity deficit) from 8.50 per cent to 8 per cent in April 2012.

Over the last six months there has been persistent demand from industry, trade and also the Finance Minister for a rate cut to prop up growth. However, the RBI has left the rate unchanged as inflation was ruling above its comfort level.

The RBI said though the recent hike in diesel prices will put some pressure on the overall price level, the near-term inflation outlook indicates that the moderation may continue through the fourth quarter of 2012-13.

“While the pressure from generalised inflation remains muted at the current juncture, risks from suppressed inflation, pressure on food prices and high inflation expectations getting entrenched into the wage-price spiral need to be reckoned with,” states the document.

The central bank cautioned that the monetary policy needs to be calibrated in addressing growth risks even as inflation remains above the comfort level and macroeconomic risks from the twin deficits — fiscal and current account — persists.

Pointing out that fiscal risks have somewhat moderated in 2012-13, the RBI said a sustained commitment to fiscal consolidation is needed to generate monetary space.

Besides, widening current account deficit, which touched an all-time high of 5.4 per cent of GDP in the July-September period, remains a constraint on monetary easing.

Policy action constrained

Given the preponderance of non-monetary factors behind the current slowdown in an environment where risks — high inflation, current account and fiscal deficits — still remain, the RBI said the scope for supportive monetary policy action is constrained.

However, as reform actions get executed, monetary policy could increasingly focus on growth revival.

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