The Reserve Bank of India (RBI) said the country's growth outlook and business climate have both weakened and warned of upward risks to inflation. The comments come a day ahead of the announcement of its policy rates due tomorrow.
The RBI kept interest rates on hold in December after raising them 13 times between March 2010 and October 2011.
RBI may choose to cut the cash reserve ratio (CRR), the share of deposits banks must maintain with the central bank, from 6 per cent to ease tight liquidity, at its review tomorrow, a CNBC-TV 18 report quoting economists said.
"Upside risks to inflation persist from insufficient supply responses, exchange rate pass-through, suppressed inflation and an expansionary fiscal stance," the RBI said in its quarterly review of macroeconomic and monetary developments.
The rupee depreciated by 16 per cent against the dollar in 2011, putting upward pressure on prices of imported goods.
Annual headline inflation, as measured by the wholesale price index, slowed to a two-year low of 7.47 per cent in December. But manufactured products inflation edged up from the previous month, reinforcing expectations the RBI will leave rates on hold even though growth is slowing.
India's economy is expected to struggle to grow by about 7 per cent in the fiscal year that ends in March, far slower than the previous year's 8.5 per cent growth.