India's central bank slashed interest rates on Friday in an effort to contain the economic fallout of the world's largest coronavirus lockdown and warned the economy could contract this year.

Even before almost all activity shut down in late March, Asia's third-largest economy was struggling to gain traction with sluggish growth, record unemployment and banks reluctant to lend.

The Reserve Bank of India (RBI) slashed the repo rate, the rate at which it lends to commercial banks, by 40 basis points to 4.0 percent, the second cut this year.

"The impact of coronavirus is turning out to be more than expected. GDP growth is estimated to remain in negative territory in 2021," bank governor Shaktikanta Das told an online news conference.

"RBI will continue to be vigilant and will take whatever measures are needed to be taken due to covid pandemic," Das added.

The RBI also lowered the reverse repo rate, the rate at which it borrows from commercial banks, by 40 basis points.

The bank had cut the repo rate by 75 basis points in March as fears grew over the spread of the virus in the country of 1.3 billion people.

The Reserve Bank of India has cut rates twice this year to support the beleaguered economy
The Reserve Bank of India has cut rates twice this year to support the beleaguered economy AFP / Indranil MUKHERJEE

Recent data have also set alarm bells ringing.

Last month the purchasing managers index (PMI) of activity in the services sector suffered its sharpest contraction since it began in 2005, while inflation soared to 8.6 percent.

Das said the global economy was headed towards a recession because of coronavirus-induced disruptions to supply chains.

India witnessed its steepest decline in trade in April, he added, with exports and imports both slumping around 60 percent.

Earlier this month Prime Minister Narendra Modi announced a 20-trillion-rupee ($266 billion) stimulus package -- 10 percent of the country's GDP -- to boost the battered economy.

Virus infections in India surged past 110,000 this week, with Mumbai -- the worst-hit city -- accounting for more than a fifth of the cases.

The rate cuts did little to soothe investor fears, with shares in Mumbai falling almost two percent Friday.