Monetary policy tools have been quite popular with the central bank to give direction to the economy. Every quarter, the Reserve Bank of India (RBI) comes out with its review of the economy and takes a decision on key policy rates. After a long period of 9 months, RBI cut key interest rates for the first time in January 2013 to support the economy which had touched the lowest growth rates in a decade. While there is hope that the RBI will continue its stance, there are a lot of factors that will decide the final outcome in the next quarter review due in March 2013. For one, there is the inflation aspect. As per the recent data, WPI inflation has hit 3 months low in the month of January 2013. While this turns the odds in favor of a rate cut in the next policy review, one must not forget that these statistics hardly capture full inflationary pressure. It is the consumer price index (CPI) which does so. There have also been some recent developments such as announcement of phased diesel price hikes that are likely to add to inflation.
Another important factor that shapes monetary policy is the fiscal deficit and current account balance (that captures net flow of a country's goods, services and transfers). Huge oil and gold imports have widened the current account deficit and threatened the economic stability and growth prospects. Unless there is some comfort in this regard, an easing in interest rates can make economy slip further.
To conclude, even though a recent decline in inflation numbers gives some room to ease rates, there are a lot of other factors that need to fall in place for such a thing to happen. We will get a lot of clarity once the budget is announced. If the budget focuses on reforms and promises fiscal consolidation, one can expect key policy rates to be eased. At the same time, if the central bank feels that the Government is slipping on the reform push, rate cuts are likely to be put on the back burner.