As markets digest the Bank of Japan's surprise policy move on Friday, the Reserve Bank of India is expected to keep rates on hold on 2 February (Tue). The focus will be on how the central bank perceives growth-inflation risks against the backdrop of recent global developments. If on-going liquidity is interpreted as 'temporary' rather than 'structural', need to lower the statutory reserve ratios will be reduced. 

Since 3Q15 the CPI inflation numbers have been inching up. The inflation rose to 5.6% YoY by December, from a low of 3.9% YoY in the September quarter. Core inflation, while still benign, has also tracked the uptrend. Other price indicators, for instance WPI inflation and PMI sub-indices are also off lows. Despite the recent climb, the inflation outlook appears manageable (excluding the impact of the public-sector wage bill). 

"We see room for a 25bp cut in March (inter-meeting)/ April if the FY16/17 Budget satisfies the central bank on the government's fiscal consolidation efforts", says DBS Group Research.

The elephant in the room however is the implementation of the pay commission's proposals and the resultant impact on inflation. After meeting this year's goals, the government's commitment to fiscal discipline will be put to test in FY16/17. Any signs of a delay in fiscal consolidation efforts could prove inflationary. RBI Governor Raghuram Rajan reiterated his concerns at a speech on Friday, where he backed fiscal consolidation over aggressive polices to boost growth. 

Tuesday's policy guidance by the RBI is likely to signal caution on the choppy market movements, but balance that with noting improvements on the ground. 

"We expect policymakers to reiterate that the stance will remain accommodative to the extent possible. Emphasis will be on meeting the 5% inflation target by March 2017, before moving down towards the medium-target of 4%. We see room for 25bps cut in April (an inter-meeting move in March cannot be ruled out)", added DBS Group Research.

Favourable base effects around mid-2016 will suppress headline inflation, providing another window (-25bps) to ease rates and plateau thereafter. But this trend will be dictated by fiscal policy decisions, especially the wage bill implementation.