India makes surprise interest rate cut, more expected

India's central bank cut interest rates by 25 basis points Thursday and signalled further reductions could come, in a surprise announcement to boost the flagging economy after inflation cooled.

In a move applauded by the government and economists, the Reserve Bank of India (RBI) cut the benchmark repo rate -- the level at which it lends to commercial banks -- to 7.75 percent, the first reduction in 20 months.

RBI governor Raghuram Rajan said falling local food and global oil prices, which have brought stubborn inflation under control, were reasons for the cut, along with the government's commitment to contain the fiscal deficit.

India's central bank cut interest rates by 25 basis points in a surprise announcement ahead of next month's policy meeting ©Indranil Mukherjee (AFP/File)

"These developments have provided headroom for a shift in the monetary policy stance," Rajan said in a statement of the cut which came ahead of next month's RBI policy meeting.

Rajan, a former IMF chief economist, added that "subsequent policy actions will be consistent with this stance".

The RBI has been under pressure from government and business leaders to reduce rates to increase lending and help kickstart the economy, which has been struggling through its worst slowdown since the 1980s.

After storming to power at elections in May, Prime Minister Narendra Modi promised to reform and revive Asia's third-largest economy by attracting more foreign investors and bolstering manufacturing.

But Rajan's priority has been to bring inflation under control, although the bank had signalled a cut would be on the cards at its February 3 meeting.

Inflation, especially high food prices, has caused much hardship for India's 1.2 billion population, of which nearly a quarter live in severe poverty, according to the World Bank.

The cut is the first since May 2013.

- 'Positive development' -

Finance Minister Arun Jaitley said the cut was a "positive development" for the economy which would "certainly help in reviving the investment cycle that the government is seeking to restore".

Commerce Minister Nirmala Sitharaman described the move as "highly encouraging", while crediting the government with bringing inflation under control.

The Bombay Stock Exchange's benchmark Sensex index surged more than three percent during trading in reaction to the cut, ending the day up 2.66 percent, while the 10-year benchmark bond yield fell to 7.66 percent.

Daniel Martin, senior Asian economist at Capital Economics, said he expected the RBI's move would mark the start of a cycle of rate cuts.

"The economy could certainly use some support, with the industrial sector, in particular, clearly struggling to gain any momentum," he added.

The economy grew 5.3 percent year on year in July-September, significantly slower than the previous three months, and far too low to help create jobs for India's millions of young people.

D.K. Joshi, chief economist at ratings agency Crisil, said the cut was a "pleasant surprise" that had come earlier than most analysts expected, and signalled inflation was now "under control".

"The central bank said they don't want to flip-flop, they wanted to be sure on inflation before a cut," Joshi said, adding that the "extraordinary" recent drop in global crude oil prices had helped.

Rajan warned in his statement that future rate reductions would depend on prudent government action including "sustained high quality fiscal consolidation" as well as continuing falling prices.

Although consumer price inflation inched up to 5.0 percent year-on-year in December, from a three-year low of 4.38 percent in November, it remained well within the RBI's comfort zone of 6.0 percent.

The Wholesale Price Index, released on Wednesday, rose a marginal 0.11 percent in December from a year earlier, compared with zero percent in November -- the lowest rate since July 2009.

The RBI kept the cash reserve ratio at 4.0 percent, but cut the reverse repo rate at which the RBI borrows from commercial banks by 25 basis points to 6.75 percent.

An Indian man watches share prices displayed outside the Bombay Stock Exchange (BSE) building in Mumbai on January 15, 2015 ©Punit Paranjpe (AFP)

Inflation, especially high food prices, have caused much hardship for India's 1.2 billion population, of which nearly a quarter live in severe poverty, according to the World Bank ©Sajjad Hussain (AFP/File)

Indian stock dealers watch stock prices on their screen during at a brokerage house in Mumbai on January 1, 2015 ©Indranil Mukherjee (AFP/File)