India’s headline inflation declined sharply to 6.62 percent in January from 7.18 percent in December – its slowest pace in three years – less than 7.0 percent predicted by the economists polled by Reuters.

The Wholesale Price Index (WPI) declined as the prices of fuel and manufactured items cooled moderately in December, compared to those in the previous month. Manufacturing goods inflation declined to 4.81 percent from 5.04 percent while fuel prices rose 7.06 percent in January from those a year earlier, compared with an annual rise of 9.38 percent in December.

Core inflation fell to 4.1 percent in December from 4.2 percent in November.

The moderation in the WPI is expected to boost the positive sentiment in the market, as cooling of inflation is expected to prompt the Reserve Bank of India (RBI) to consider further interest rate cuts. The RBI slashed the key interest rates by 25 basis points in the January policy review meeting, citing the moderation in December WPI. Some analysts believe that the cooling of the headline inflation would give the central bank more elbow room to take policy decisions.

"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," A. Prasanna, economist at ICICI Securities Primary Securities Dealership in Mumbai, told Reuters.

"Acute slowdown in demand is obvious from the manufacturing products inflation at 4.8 percent and its core component at 4.1 percent. Today's inflation reading combined with further contraction in industrial production in December fortifies my view that RBI will have to reduce rates in the March policy by at least 25 bps," said Rupa Rege Nitsure, chief economist, Bank of Baroda, Mumbai.

However, the analysts also pointed out that although decoration in wholesale price inflation was a welcome sign, the higher consumer price inflation in January might restrict the central bank from going ahead with the second round of rate cuts.

"It is clearly much lower than anticipated. Things are moving in the right direction, it is positive and encouraging for the Reserve Bank of India. However, other factors will have to fall into place before the RBI eases again, and that includes continuation of structural reforms and what the budget brings,” said Leif Eskesen, HSBC chief economist for India and ASEAN, Reuters has reported.

India’s trade balance has widened to $20 billion in January on surging crude oil imports raising the concern over the mounting current deficit while the data from the Indian statistical organization had put India’s economic growth for the current fiscal year at 5 percent, much less than the growth expected by various international agencies and the government.

The Bombay Stock Exchange’s Sensex, which headed to the green terrain following the lower-than-expected WPI data in the morning session, fell about 0.1 percent in the afternoon session as the investors remained cautious ahead of the union budget for the year 2012-13, which will be presented in the parliament Feb 28.