The Reserve Bank of India (RBI) snipped the key monetary policy rate by 25 bps to 7.25 per cent in its bi-monthly policy review meet on Tuesday citing subdued inflationary pressures, low domestic capacity utilisation and muted investment and credit growth.
This is the third rate cut this year.
The central bank highlighted that with banks passing on the rate cut to consumers, muted price increases given the moderate impact of unseasonal rains and the delay in the timing of normalisation of US monetary policy as reasons for a rate cut in its Tuesday meeting.
The decision was in line with the market expectations for another rate cut in the June policy review. Of the 20 economists polled by VCCircle all but two predicted a rate cut in the current meeting.
Some, however, hoped that the RBI would cut the rate by 50 bps.
The 30-stock benchmark index Sensex was down 1.3 per cent soon after the announcement.
RBI retained the existing statutory liquidity ratio or SLR and cash reserve ratio or CRR. SLR is the reserve requirement that commercial banks are expected to maintain in the form of cash, gold or government approved securities before providing credit to the customers. CRR is the amount of cash banks have to keep with RBI.
While the central bank in its last review had expressed concerns over the transmission mechanism, banks since then have only passed on 25 bps rate cut to the consumers. While the banks have been reluctant to pass on the rate cuts given their falling profitability, RBI reiterated its stance for banks to pass on the rate cuts to the customers.
RBI was dovish in its tone on the future course of monetary policy given the risks to inflation from anticipated below-normal monsoon and crude prices firming up again.
"A conservative strategy would be to wait, especially for more certainty on both the monsoon outturn as well as the effects of government responses if it turns out to be weak. With still weak investment and the need to reduce supply constraints over the medium term to stay on the proposed disinflationary path however, a more appropriate stance is to front-load a rate cut today and then wait for data that clarify uncertainty," RBI said.
Meanwhile, the central bank revised its outlook for growth downwards from 7.8 per cent to 7.6 per cent in the current fiscal given the balance of risks and downward revision to GVA estimates released by the government for 2014-15. It also revised the inflation forecasts upwards to 6 per cent in January 2016 putting more weight to IMD's forecast of below normal monsoon.
This is the upper end of the 2-6 per cent consumer inflation bracket that RBI is now targeting to achieve through its monetary policy moves as part of a flexible inflation target strategy.
RBI put the onus of growth on the government indicating that a targeted infusion of capital into the banking sector would help them clean up stressed assets to improve credit flows. It added that monetary easing can only create the enabling conditions for a fuller government policy thrust that hinges around a step up in public investment in several areas that can also crowd in private investment.
The third bi-monthly monetary policy statement for fiscal year 2015-16 is scheduled on August 4, 2015.