NEW DELHI (Reuters) - India's headline inflation likely moderated to its lowest level in more than three years in January, helped by a slower rise in prices of manufactured goods, which should give policymakers more leeway to revive a slowing economy.
The government will release the data around 0630 GMT on Thursday.
Wholesale prices -- India's main inflation gauge -- probably rose 7 percent last month from a year earlier, according to a Reuters poll of economists, the slowest pace since November 2009.
Headline inflation stood at 7.18 percent in December.
"If the moderation in inflation continues and core inflation stays around the level recorded in December 2012, there is a likelihood that the RBI may cut interest rates by another 25 basis points in the mid-quarter policy review in March 2013," said Aditi Nayar, senior economist at ICRA Ltd.
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. The slowing growth is a major worry for the Congress-led coalition government as it gears up for a general election due by May 2014.
Worried about the deepening economic slump and encouraged by a slowing trend in inflation, the Reserve Bank of India (RBI) last month cut interest rates for the first time in nine months.
But it warned that the room for further monetary easing was limited unless inflation and a high current account deficit improved by more than expected.
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 widely expected to widen further in the subsequent quarter on falling merchandise exports.
"Prior to reducing the policy rate in January, the RBI had indicated the current account deficit in the December quarter may exceed the level seen in the second quarter. So, if the Union Budget indicates no major slippage as compared to the revised targets for the fiscal deficit and core inflation does not display an uptrend, we expect the RBI to cut the policy rate in March," Nayar said.
Finance Minister P. Chidambaram will present the 2013/14 budget on February 28.
Even if inflation moderates as expected, levels around 7 percent remain way above the Reserve Bank of India's (RBI) perceived comfort level of between 4-4.5 percent. Still, many economists believe a weak economy will force the central bank to deliver another interest rate cut next month.
Slowing growth has prompted several G20 economies to embark on looser monetary policies, which have lessened the value of their currencies and raised the spectre of competitive currency devaluations. India, in contrast, stands as an outlier, grappling with both flagging growth and high inflation.
Prime Minister Manmohan Singh's failure to improve India's power supply, fast-track stalled tax reforms and speed up environmental clearances and land acquisition for new projects has hit capital investments, which are on track to hit at least a five-year low this financial year.
Slowing economic activity is also constraining resources for the government's flagship welfare programmes. It has also made it tougher for Chidambaram to trim a swollen fiscal deficit that has put the country in danger of losing its investment grade credit rating.
With very little resources at its disposal to cut the fiscal deficit -- among the widest in major emerging economies -- the government is resorting to deep spending cuts, which are further clouding near-term growth prospects.
Chidambaram can ill afford to offer any expensive pump-priming measures in the budget.
The government has launched a slew of initiatives since September last year that included opening retail and aviation sectors to more overseas investments, cutting budget-busting fuel subsidies and delaying tax changes that threatened to deter capital inflows.
While local stock markets have rallied in response to those steps, there are few signs that the measures have boosted economic activity thus far.
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.
Reporting by Rajesh Kumar Singh; Editing by Kim Coghill