(Reuters) - The Reserve Bank of India cut its repo interest rate by 25 basis points to 7.75 percent in a surprise move on Thursday, making its first reduction in a year as inflation showed signs of slowing and the government was making efforts to contain the fiscal deficit.
The RBI added it could cut interest rates further should inflation continue to ease, while it would also monitor the government's progress on fiscal consolidation.
Helped by plunging global oil prices, India's wholesale price index for December rose just 0.11 percent year-on-year, after staying flat in November, according to data released on Wednesday. A Reuters poll of economists had forecast a 0.6 percent rise.
Retail inflation, meanwhile, rose to 5 percent in December -- below the 5.4 percent annual rise predicted by analysts in a Reuters poll. The RBI is targeting retail inflation of 6.0 percent by January next year.
In a statement, the RBI cited lower-than-expected inflation, weak crude prices and weak demand as the reasons for its move, as well as the government's commitment to sticking to a fiscal deficit target.
"These developments have provided headroom for a shift in the monetary policy stance," it said.
The move, ahead of a Feb. 3 RBI policy meeting and the government's annual budget statement at the end of next month, caught markets off guard.
While the early move was unexpected, aggressive reductions in rates were expected over the course of the year to help India's economy out of a rut, with growth rates struggling to recover from their weakest level in a quarter century.
"The cut was expected in first quarter, but has come sooner than expected and frontrun the February budget," said Radhika Rao, economist at DBS Bank Ltd.
"This demonstrates RBI’s confidence in the evolving inflation outlook and it shows that they are putting faith in government’s fiscal consolidation plan."
The 1-year overnight indexed swap (OIS) earlier this week to as much as 7.59 percent, its lowest since July 2013. According to traders' calculations, that signals expect interest rates to fall below 7 percent.
The finance ministry said it had no immediate comment on the RBI cut and but would issue a statement.