The headline inflation rate moderated to its lowest level in more than three years in January, helped by a slower rise in fuel and manufactured goods prices, which could give policymakers more leeway to revive a slowing economy.
Wholesale prices -- India's main inflation gauge -- rose 6.62 percent in January from a year earlier, the slowest pace since November 2009 and below the 7.0 percent annual rise predicted by economists in a Reuters poll. Headline inflation stood at 7.18 percent in December.
"This shows that finally inflation is easing, and fits with the growth slowdown," said A. Prasanna, economist at ICICI Securities Primary Securities Dealership in Mumbai.
"I think March inflation will be lower than RBI's (Reserve Bank of India) projection and that should give RBI the comfort to cut rates by 25 basis points in March."
Fuel prices rose 7.06 percent in January from a year earlier, compared with an annual rise of 9.38 percent in December.
Manufacturing goods inflation dropped to 4.81 percent from 5.04 percent in January. Non-food manufactured inflation - a barometer for demand-driven price pressures - eased to 4.1 percent during the month from 4.2 percent in December.
C. Rangarajan, the chief economic adviser to Prime Minister Manmohan Singh, said the January number was "a welcome sign" and forecast inflation would drop to 6.5 percent by March, with core inflation stabilizing below 4 percent.
The reading for November was unrevised at 7.24 percent.
India's 10-year government bond yield fell 3 basis points after the data. The 10-year yield was trading at 7.81 percent from its 7.84 percent close on Wednesday.
The one-year OIS swap rate fell 2 basis points to 7.60 percent.
The RBI had forecast a moderation in headline inflation in the January-March quarter when it cut interest rates by quarter percentage points last month. But, it also warned that inflation would have to ease more than expected, and the current account deficit would have to come down, to enable the bank to make further reductions in rates.
India's current account deficit hit an all-time high of 5.4 percent of gross domestic product in the July-September quarter and is expected to widen further in the subsequent quarter.
The RBI will also be watching Finance Minister P. Chidamabaram's annual budget statement on Feb 28, to see how the government intends to reduce a swollen fiscal deficit and boost economic growth. The central bank regards fiscal consolidation by the government as a necessary condition for monetary easing.
Asia's third-largest economy has been hamstrung by weak capital investment and flagging consumer demand. A series of government policy U-turns and a slowdown in the rate of implementing key industrial and infrastructure projects have added to investor gloom.
Economic growth is likely to be just 5 percent in the fiscal year ending in March, according to a government forecast issued last week, a sharp fall from the near double-digit growth rates of the mid-2000s, and the slowest growth in a decade.
The sluggish economy is a major worry for the Congress-led coalition government as it gears up for a general election due by May 2014.
Industrial production unexpectedly shrank for a second straight month in December, casting doubt on the government's view that the economy is showing signs of recovery. Output has grown in just three of the last nine months.