The country’s central bank is trying to strike a balance between the conflicting pressures from high inflation and a need to spur lending by banks to boost economic growth.
In its third quarter monetary policy review on Tuesday, the reserve bank cut the rate at which the RBI lends money to commercial banks by 25 basis points to 7.75 percent and the rate at which the RBI borrows money from commercial banks to 6.75 percent from 7 percent. The move was in line with the expectations of analysts polled by Reuters.
The last rate cut in April saw RBI slashing the lending rate by 50 basis points. Concerns are growing that any further rate reductions will adversely affect inflation in Asia's third-largest economy, which in December was at a three-year low of 7.18 percent.
A reduction in the repo rate makes borrowing from the RBI cheaper, prompting banks to ease the cost of loans to customers for home and car financing and borrowing to expand business operations, among other types of consumer lending.
In an unexpected move, the central bank also reduced the cash reserve ratio -- the amount of funds that banks have to keep with the RBI -- by 25 basis points from 4.25 percent to 4 percent. The move will free up capital banks have to lend by 180 billion rupees (about $3.3 billion).
"RBI has not abandoned its cautious stance, stressing on the 'calibrated and limited' nature of rate support (from) hereon," Radhika Rao, economist, Forecast Pte in Singapore told Reuters. "The scale of rate cuts is closely tied to the government's sustained efforts to correct the twin imbalances and moderating inflation trajectory."
The much-awaited rate cuts come amid concerns of spiraling food and fuel prices in the first month of the year.
The RBI reduced India’s growth projections for the current year to 5.5 percent from 5.8 percent. On inflation, it lowered the first quarter projection to 6.8 percent from 7.5 percent.
“With headline inflation likely to have peaked and non-food manufactured products inflation declining steadily over the last few months, there is an increasing likelihood that going into 2013-14, inflation will remain range-bound around the current levels. This provides space, albeit limited, for monetary policy to give greater emphasis to growth risks,” RBI said in its guidance summary.
The Central Bank reiterated its deficit concerns.
"Financing the [current account deficit] with increasingly risky and volatile flows increases the economy's vulnerability to sudden shifts in risk appetite and liquidity preference, potentially threatening macroeconomic and exchange rate stability," the RBI said.
The central bank had kept interest rates on hold as inflation remained stubbornly high despite repeated calls from the government and industry for a cut.
Indian stock markets remained range-bound Tuesday morning after the central bank’s announcement.