NEW DELHI (Reuters) - Slowing growth and a fall in commodity prices may help rein in inflation, a deputy governor of the Reserve Bank of India said on Tuesday, fueling expectations of a rate cut in the central bank's April monetary policy review.
Bond yields and swap rates fell in response to the comments. Yields had risen sharply after the government announced a higher-than-expected borrowing programme for 2012/13 in its budget on Friday.
Subir Gokarn, who handles monetary policy, said that crude oil prices were not the only factor impacting inflation, but other variables like the exchange rate also play a role.
A possible softening in food prices on a good monsoon and the government's supply side initiatives in the budget will help in keeping prices in check, he said.
"If those prices (commodity) come down, then the inflation dynamics change completely and that creates space," Gokarn said at an industry event.
"There is also growth moderation that we are seeing which might help to contain inflation from the demand side."
However, RBI Governor Duvvuri Subbarao separately said he remains worried about inflation in essential items like food and fuel.
India's headline inflation rose 6.95 percent from a year earlier in February, after a spike in vegetable prices fanned food inflation.
Finance Minister Pranab Mukherjee announced a fiscal deficit target of 5.1 percent for 2012/13 fiscal year beginning April that will entail a borrowing of 5.7 trillion rupees, higher than a consensus of 5.3 trillion rupees.
The hopes of a rate cut in April diminished after the high borrowing numbers as the RBI had been saying credible fiscal consolidation will be a key for cutting policy rates.
The central bank, after the budget, recognized the government's effort to bring down the fiscal deficit, but did not commit on the timing of any interest rate cut, saying it hinged mainly on global oil prices and domestic growth.
"The market reacted adversely to the borrowing numbers in the budget. Also RBI said in its policy that inflation was still a concern and so today market is lapping up the positive comment from Gokarn on inflation," said Ashok Gautam, global head of markets at Axis Bank.
The 10-year benchmark bond yield fell 1 basis point to 8.39 percent following Gokarn's comments, while the benchmark five-year swap rate and the one-year rate eased by 2 basis points each to 7.60 percent and 8.20 percent respectively.
The 10-year bond yield had touched two and half month high of 8.45 percent on Friday and revisited the same level on Monday on worries of a huge supply burden.
Writing by Suvashree Dey Choudhury; Editing by Subhadip Sircar