Finance Minister P. Chidambaram's comments on Monday have revived the prospect of monetary easing just a week after the Reserve Bank of India (RBI) di sappointed investors by keeping the repo rate on hold and sticking to its hawkish language on inflation.

Although India's central bank is independent and will not review policy until September, traders say the newly-appointed minister's stance signals the government could start to exert pressure on the RBI to ease interest rates.

RBI Governor Duvvuri Subbarao has said the government would need to adopt fiscal reforms, rather than rely on monetary policy alone, to revive an economy that is growing at the slowest pace in a decade.

"People are expecting that Chidambaram will influence RBI to do whatever he wants," said Harish Agarwal, a fixed income dealer with First Rand Bank.

"Market is now starting to discount a rate cut in the September policy," he added.

India's benchmark 10-year bond yield dropped 8 basis points to 8.14 percent, bringing its fall for the week so far to 12 basis points.

Bond yields retreated sharply last week after the RBI's repeated warnings on inflationary pressures led traders to pare expectations for future rate cuts.

The drought is adding to inflationary fears, and some analysts have warned it could delay meaningful fiscal reforms such as a hike in diesel prices.

On Tuesday, Indian rating agency CRISIL slashed the country's growth forecast to 5.5 percent for the fiscal year ending March, one of the lowest estimates out there, while raising its inflation projection to 8 percent from 7 percent in part because of the bad monsoon.

Benchmark five-year OIS rate fell 2 bps to 7.01 percent, while the one-year rate also retreated 2 bps to 7.69 percent.