Indian inflation fell to a nine-month low in mid-December, helped by cheaper fuel and lower factory taxes, and analysts saw it diving to around 2 percent by March, freeing the central bank to cut rates deeply.
India's wholesale price index, the most widely watched inflation measure, rose 6.61 percent in the 12 months to December 13, slower than 6.84 percent in the previous week but a shade above a Reuters poll of 6.57 percent.
"It certainly means the second-round effects of the fuel price cuts and duty cuts are kicking in and inflation is also tapering off very fast due to the disinflationary effects of manufactured goods," said Rupa Rege Nitsure, an economist at Bank of Baroda.
"I expect inflation at 3 percent by end-March 2009 and expect the central bank to cut interest rates by 100 basis points and reduce banks' cash reserve requirements by 50 basis points."
In early December, the government lowered state-set prices of diesel and petrol and announced a 4-percentage point cut to value-added tax on a range of manufactured products.
The government said this week the central bank had considerable scope for monetary easing next year and aggressive monetary action may be needed if the global downturn continued to hurt manufacturing and slow growth.
This was India's lowest reading since March 1, and inflation has now nearly halved from early August's peak of 12.91 percent.
It is well within the central bank's forecast of around 7 percent for 2008/09 and some economists saw it falling below two percent by March-end.
Most analysts now expect the central bank to cut interest rates by another 100 basis points, a sentiment echoed by a top economic adviser to the government this week.
After slashing rates since mid-October, the central bank's key lending or repo rate now stands at 6.5 percent and the reverse repo rate, at which it absorbs cash from the market, stands at 5.0 percent.
Financial markets were relatively unruffled with the 10-year benchmark bond yield briefly easing one basis point to 6.56 percent and the rupee hovering closed to 48.00 per dollar.
India's $1 trillion (677.2 billion pounds) economy, Asia's third-biggest, has shown palpable signs of slowing after growing at 9 percent or above for the past three years.
Factory output growth has fallen sharply, companies have shelved expansion plans and laid off staff, and export growth has dropped as global demand weakened.
Economists and government advisers and officials expect growth to slow to around 7 percent this fiscal year and the central bank's chief said earlier this month that 2009/10 looked like being an even more challenging year.
