Warning of upside risks to its 2016 inflation target, the RBI said policy moves would hinge on inflation trends.

Consumer price inflation slowed to 7.8 percent in August, making the RBI far more confident that the near-term target of 8 percent inflation in January would be met.

In a separate report on inflation, the RBI spelled out its concerns for the future, noting elevated inflation expectations among households and an enduring risk of higher food prices because structural issues were taking time to solve.

The central bank projected inflation to ease to 6 percent by November but soon rise to around 8 percent by January through March 2015 as a favourable base effect is likely to reverse.

A Reuters poll last week showed most analysts expect the RBI will not cut interest rates until the April-June quarter.

"The key takeaway is that the central bank is now focused on achieving the 6 percent inflation target rather than the 8 percent target," said Soumyajit Niyogi, an analyst for SBI DFHI Primary Dealership.

ECONOMY TO GROW FASTER

Investors in India's bonds are happy with the priority Rajan gave to breaking the "back of inflation" in a speech last week. And, on Tuesday, the benchmark 10-year paper was down 1 basis point to 8.48 percent from its previous close.

Filled with hope by the election of Prime Minister Narendra Modi last May, investors in India's booming stock market have been undeterred by the high interest rates.

The new Modi government has backed Rajan, though the RBI's strategy is far less popular with businesses, which want relief from high interest rates, and banks which want to lend more.

The RBI on Tuesday reiterated its economic growth projection at 5.5 percent for 2014/15 and said it expects the economy to grow 6.3 percent in 2015/16.

Modi's reformist government will want more priority to be given to boosting economic growth, but it will have to play its part by remedying structural issues that create supply bottlenecks, and by reducing its fiscal deficit.

In the absence of rate cuts, all the RBI has offered so far this year to help growth has been modest measures to make more credit available.

Ultimately, India needs far stronger investment if it is to decisively recover from the sub-five percent growth suffered in the past two years, and grow fast enough to provide jobs for the millions of young people entering the labour market.

The Reserve Bank of India (RBI) kept its key policy repo rate unchanged at 8.0 percent on Tuesday, as widely expected, while expressing concern about risks to its target to bring consumer inflation down to 6 percent by January 2016.

The Reserve Bank of India also kept both the statutory liquidity ratio (SLR) and the cash reserve ratio (CRR) unchanged.

COMMENTARY

KUMAR RACHAPUDI, SENIOR RATES STRATEGIST, ANZ, SINGAPORE:

"The overall stance of the RBI remains cautious even though it mentioned that the risks to its inflation objective have somewhat decreased from pre-policy. From a markets perspective, the impact of reduction in HTM assets is marginally negative for bonds".

KILLOL PANDYA, SENIOR FUND MANAGER - DEBT, LIC NOMURA ASSET MANAGEMENT, MUMBAI

"The policy is totally in line with expectations. There have been no surprises at all. RBI Governor Raghuram Rajan remains worried about inflation. The governor worries that inflation would not remain at a lower level in the long run. I think RBI has given a guidance of wait-and-watch policy on interest rates. He has asked the government to reduce bottlenecks to ease food inflation which fall under fiscal space than monetary."

R. SIVAKUMAR, HEAD OF FIXED INCOME, AXIS MUTUAL FUND, MUMBAI:

"Our expectation is that even after the base effect is accounted for, inflation by January 2015 will be substantially lower than 8 percent.

RBI is going to roll the goalpost one year forward, and if the CPI inflation moves towards 7 percent then we expect a gradual pace of rate cuts, and if inflation moves closer to their target 6 percent then we can probably expect a more aggressive rate of pace cuts.

The reaction on HTM cuts was already priced into the market and it is very muted. We continue to believe cuts in HTM and SLR requirements over a period of time will be driven by RBI's goals to have banks meet their Basel-III liquidity norms."

BACKGROUND

- India regained its "stable" rating from Standard and Poor's on Friday, more than two years after an embarrassing downgrade, in a validation of Prime Minister Narendra Modi's ambitious agenda of economic and fiscal reforms.

- Reserve Bank of India Governor Raghuram Rajan said the country suffered from "persistent" inflation, adding India had to act, while also noting the need for more data across important economic indicators such as employment and producer prices.

- The RBI Governor said India's macroeconomic indicators are improving and inflation has been coming down consistent with the central bank's forecast, but Asia's third-largest economy needs investment growth to pick up.

- India's wholesale price inflation eased to its lowest level in nearly five years in August, but the central bank is likely to keep interest rates on hold later this month to prevent a revival in price pressures once the economy gains momentum.

- India's state banks need to improve monitoring of loans and root out "bad apples" and "bad practices," Reserve Bank of India Governor Raghuram Rajan said, as the sector continues to struggle with bad assets.

- Retail inflation, which the central bank tracks for setting lending rates, edged down marginally to 7.8 percent in August from 7.96 percent a month earlier, helped by slower annual rises in prices of fuel and clothes.

- The RBI, which wants to bring retail inflation down to 6 percent, received conditional support for this target from Finance Minister Arun Jaitley who is putting emphasis on stronger economic growth.