NEW DELHI India's headline inflation rate is expected to have accelerated in September to its highest this year after the government raised subsidised fuel prices, but the central bank will remain under pressure to cut rates at a policy meeting this month.
A Reuters poll forecast the wholesale price index - India's main inflation gauge - rose an annual 7.7 percent, faster than 7.55 percent in August and well above the central bank's comfort level of 4-5 percent.
The government will release the data around 7 a.m. British time on Monday.
Faced with a big hole in the budget and the prospect of losing its investment grade credit rating, the Indian government increased the price of heavily subsidised diesel on September 13 to rein in spending.
On Friday, consumer price data, traditionally less closely watched in India, showed lower inflation than in recent months. However, diesel weighs heavier on the WPI index and economists expect the price hike to be reflected more there.
"The WPI can move to over 8 percent, largely because of the new domestic oil pricing policy, as well as the build-up of food prices in the domestic and international market," said N.R. Bhanumurthy, an economist at the National Institute of Public Finance and Policy, a partly government-funded think-tank.
Diesel is widely used by trucks ferrying food and other commodities around the country. Analysts expect inflation to quicken more in the coming months because fuel and food make up over a third of the wholesale price index. Overall fuel inflation was 8.32 percent in August.
The Reserve Bank of India has kept its key policy repo rate unchanged at 8 percent since April, citing the risks from stubbornly high inflation.
Businesses and politicians argue that any price spike from the fuel subsidy cut will be short-lived. They say the overall inflation trend is downward and point to the government's recent attempts to tackle the deficit to make the case for a more growth orientated monetary policy.
A few economists think WPI inflation will fall, arguing that weak demand will offset fuel prices.
Data on Friday showed India's industrial output rose modestly in August, but not enough to end an industrial slump stretching back to February. In the first six months of 2012 India grew at its slowest rate since the depths of the global financial crisis three years ago.
Last week, the International Monetary Fund lowered its 2012 growth forecast for India to 4.9 percent from 6.1 percent.
Several finance ministry officials have said a 25 basis point cut is warranted at the RBI's next policy review on October 30. Finance Minister P. Chidambaram gave the RBI a further prod in an interview with Reuters on Saturday, when he called for the central bank to take "calibrated risks" to support the economy as a reciprocal measure to government fiscal efforts.
India's one-month overnight interest rate swaps (OIS) were trading slightly below the 8 percent repo rate on Friday, indicating investors were cautiously positioned for a rate cut but unconvinced it will happen this month.
"My take on the RBI would be that it can hold on interest rates in the next policy review while taking measures to ease liquidity through open market operations and a cut in CRR," Bhanumurthy said, referring to the cash reserve ratio - the amount the central bank requires lenders to hold as reserves.
With barely 18 months until the next general election, Prime Minister Manmohan Singh is trying hard to get the economy back on track, partly to fund big-ticket welfare programmes ahead of the 2014 vote.
As well as increasing fuel prices, in the last few weeks he has opened up the retail sector to global supermarkets, allowed foreign airlines to buy stakes in local carriers and proposed raising the bar on foreign direct investment in insurance firms.
But that may not be enough to rescue an economy a government panel recently said was teetering at a fiscal precipice.
Headline inflation has averaged 8.7 percent since January 2011. And still-high spending on fuel, food and fertilizer subsidies could drive the fiscal deficit to 6 percent of GDP for the financial year ending in March, above New Delhi's target of 5.1 percent, Standard & Poor's said last week.
The rating agency reiterated its warning that India still faced a one-in-three chance of a credit rating downgrade over the next 24 months.
The response to the global economic slowdown could also keep the RBI on a tight leash. Massive asset purchase programmes unveiled by central banks in the United States, Europe and Japan are expected to stoke global commodity prices, which would keep domestic prices on the boil.
(Editing by Frank Jack Daniel and Alex Richardson)