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India Inflation Optimism Overdone, Rate Cut Unlikely
CNBC.com | March 14, 2012 | 03:15 AM EDT

Continuing global economic uncertainty and recent political setbacks for India's ruling Congress party has again put the onus on India's central bank, which meets on March 15, to boost investor confidence.

However, the Reserve Bank of India should stay true to its job of delivering sustained low inflation . This will require the central bank to avoid cutting interest rates this week despite the deceleration in growth – in the fourth quarter of 2011 India’s economy grew at its slowest pace in three years at 6.1 percent.

It is fashionable to blame monetary tightening for the investment slump, and while it has contributed to the moderation – as it was meant to – the more important reason lies with government policy inaction and the fallout from the corruptionscandals that hurt business confidence.

There is much overdone optimism about improving inflation data and the aggressive monetary easing that it could trigger. The Wholesale Price Index (WPI), India's main inflation gauge, eased to a two-year low of 6.6 percent year on year in January due to a combination of the lagged effect of monetary tightening, a seasonal fall in food prices and the favorable effects of last year’s high base. However, the improvement in the inflation rate is somewhat artificial, as the government has avoided raising local fuel prices due to the recent state elections, despite rising global crude oil prices.

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