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Asia's third largest economy braces for rate cut to battle low inflation

  • The Reserve Bank of India was widely expected to cut its benchmark rate by 25 basis points to 6 percent on Wednesday
  • Benign inflation was the key factor behind the call for RBI to cut rates, economists said

The Reserve Bank of India was widely expected to cut its main policy rate to the lowest in the more than six years on Wednesday to battle low inflation — a common sticking point for policymakers globally.

A Reuters poll found that 40 out of 56 economists expected the RBI to cut its repo rate by 25 basis points to 6 percent on Wednesday. That is the lowest rate India has seen since November 2010, according to Reuters.

Inflation in Asia's third largest economy has missed forecasts for the last six to seven months, noted DBS economist Radhika Rao. The latest data showed inflation slipped to 1.54 percent in June due to a slump in food prices, below RBI's 2 to 3.5 percent target for the April-September period.

"Domestic factors are likely to be given a higher weightage in swaying the decision, compared to global factors," Rao wrote in a Wednesday note ahead of RBI's decision.

"The policy committee is expected to shed its innate bias to be cautious and lower rates … Odds for further easing will arise if the other inflation catalysts — better growth, farm loan waivers and imported pressures — turn out to be more benign than assumed," she added.

The RBI has held its repo rate at 6.25 percent since October 2016. Lowering the benchmark again will also allow the central bank to steer growth at a time when the country was coming to terms with the new goods and services tax (GST), economists said.

GST, India's largest tax reform thus far, hit factory activity last month. The country's manufacturing purchasing managers' index (PMI) slipped into contraction territory in July in the largest month-on-month decline since November 2008.

Although many economists saw that slide in PMI as temporary, some warned that growth prospects for the year were still dampened by soaring bad debt in the economy.

"A lot of people are asking: will a rate cut actually help growth? And my answer is: yes and no. No, if that's the only step we take, but yes if you have a rate cut along with other steps taken to restore the banking sector to health," Pranjul Bhandari, HSBC's chief India economist, said on CNBC's "Capital Connection."

"The RBI is taking the driver's seat in resolving a lot of the corporate debt and banking debt, the stock of non-performing loans that have accumulated in the country … so things are happening. They're not happening very quickly, but they're happening in the right direction," she added.