The Reserve Bank of India on Tuesday cut its key monetary policy handle, the repo rate, by a wider-than-expected 50 basis points to a four-year low of 6.75 per cent to support economic growth.
The central bank's fourth rate cut this year creates a stage for lower borrowing costs that may spur investments and boost consumer spending.
While most analysts and economists had expected the rate to be snipped to 7 per cent, the bigger reduction was in sync with the call made by Arvind Panagariya, vice chairman of planning body NITI Aayog, for a 50 bps rate cut. RBI Governor Raghuram Rajan had been under pressure from the government as well as industry to ease monetary policy to boost the economy.
The stock market bounced back after falling more than 1 per cent in early morning trade on Tuesday. The 30-stock benchmark Sensex was up 0.86 per cent at 1.05 pm.
The reduction comes as inflation in India has remained well within the comfort zone, thanks partly to lower global commodity prices, and the US Federal Reserve has delayed a rate hike that could prompt foreign portfolio investors to pull out money from India and weaken the Indian currency.
Although many analysts had expected the RBI to cut rates by 25 bps each in September and December, the RBI signalled it may halt the rate-cutting exercise for some time.
The RBI said the focus will now shift to bringing inflation to around 5 per cent by the end of 2016-17
"While the Reserve Bank’s stance will continue to be accommodative, the focus of monetary action for the near term will shift to working with the government to ensure that impediments to banks passing on the bulk of the cumulative 125 basis points cut in the policy rate are removed," Rajan said in his monetary policy statement.
The RBI's three previous rate cuts this year of 25 bps each have failed to push banks to pass on the full benefit to borrowers. This has not helped corporate investments, seen crucial to rev up economic growth.
Growth outlook, inflation target
India's GDP grew by a lower-than-expected 7 per cent in the first quarter ended June 30. Several think tanks, rating agencies and development finance bodies have cut their growth outlook for India, even though many expect India to be the fastest-growing major economy in the world as China's economy slows after decades of rapid expansion.
Indeed, the RBI too lowered its growth forecast for the current fiscal year, from 7.6 per cent to 7.4 per cent.
"Underlying economic activity, however, remains weak on account of the sustained decline in exports, rainfall deficiency and weaker than expected momentum in industrial production and investment activity," it said.
The central bank remained optimistic that consumer inflation would be around 5.8 per cent, close to the upper end of 2-6 per cent target band by January 2016.
"Despite the monsoon deficiency and its uneven spatial and temporal distribution, food inflation pressures have been contained by resolute actions by the government to manage supply," the RBI said.
The central bank cautioned that inflation is likely go up from September as favourable effects dissipate but said that commodity prices will keep the number in check. The RBI is wary of the recent depreciation of the Indian currency but said that the focus will now shift to bringing inflation to around 5 per cent by the end of fiscal 2016-17.
Meanwhile, the RBI kept unchanged the statutory liquidity ratio, or SLR, and the cash reserve ratio, or CRR. SLR is the reserve 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 the RBI.