Inflation has sharply decelerated in India since the Reserve Bank of India's (RBI) Governor Raghuram Rajan took over in September 2013. Slowdown was witnessed in both the inflation gauges of CPI and WPI.

The oldest inflation measure, WPI (Wholesale Price Index), has decelerated to -0.9 percent in January 2016 from 10 percent y/y level in early 2010. Collapse in commodity and oil prices mainly caused the WPI inflation to slow down. CPI (Consumer Price Index) is now being used as the measure of inflation by the Reserve Bank of India. CPI inflation slowed to 5 percent in early this year from 8.3 percent in the first quarter of 2014.

Rajan, when taking office in 2013, had mentioned that he intended to rein in inflationary expectations apart from tackling current inflationary pressures. According to him, this would help in anchoring inflation in future and assist in ensuring a steady inflation backdrop. Rajan’s hawkish stance in the initial phase of his tenure partially helped achieve it. The central bank has kept its medium to long term inflation target in the range of two to six percent with the mid-point at four percent.

In 2014, the Reserve Bank kept the policy tight on purpose to rein in inflationary expectations. The deceleration of inflation gave the leeway to the central bank to begin rate cuts in 2015. Last year, the central bank reduced rates to 6.75 percent, cutting by a total of 125bp. With inflation continuing to weaken, the RBI reduced rate further by 25bp to 6.50 percent in April 2016.

This year, the central bank is expected to further cut rates by 25 -75 basis points, said Commerzbank in a research report. But the reduction in rate will be dependent on stable financial markets and steady inflation. RBI’s wish to keep a real interest rate of about 1.5 percent- 2 percent might be a limitation. As inflation is expected to be around 5 percent in the coming year, policy rate is likely to be around 6.5 percent – 7 percent, added Commerzbank.

The material has been provided by InstaForex Company – www.instaforex.com