Mumbai: The Reserve Bank of India (RBI) on Tuesday lowered its benchmark interest rate by a higher-than-expected 50 basis points to a four-year low, seeking to ease borrowing costs and stimulate economic growth by taking advantage of record-low consumer price inflation.

Governor Raghuram Rajan reduced the repo rate, at which the central bank lends to commercial banks, to 6.75% from 7.25% in the fourth cut since the start of January. The repo rate has been cut by a total of 125 basis points this year.

One basis point is one-hundredth of a percentage point. Ten bank economists and executives polled by Mint had expected a cut of no more than 25 basis points.

The higher-than-expected rate cut should silence critics who believe RBI’s insistence on inflation control above all else has come at the cost of economic growth, which slowed to 7% in the three months ended June from 7.5% in the preceding quarter.

State Bank of India, the country’s largest lender, responded swiftly with a 40 basis point cut in its base rate, the rupee strengthened, bond prices rose and stock indices jumped after the rate cut.

RBI will maintain an accommodative stance, but 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, referring to the quantum of rate cuts since January.

Finance minister Arun Jaitley welcomed the rate cut, which followed implicit government calls for a lowering of borrowing costs to stimulate investment and lift growth in the economy.

“We are now looking forward to transmission of the cuts which will effectively help boost investment and confidence," he told reporters.

Rajan noted that global growth had moderated, especially in emerging market economies (EMEs), since August when he made his last policy statement. The 17 September decision by the US Federal Reserve to hold interest rates steady in response to global conditions and weak domestic inflation lifted financial markets briefly, “but overall financial conditions are yet to stabilize", he said.

“In India, a tentative economic recovery is underway, but is still far from robust," he said, noting that monsoon rainfall is deficient by 14% although foodgrain production is expected to be higher than last year.

“Manufacturing has exhibited uneven growth in April-July, with industrial activity slowing sequentially in July, although it has been in expansionary mode for the ninth month in succession," he said.

Capacity utilization by manufacturing and industrial units is still low at around 70-72%. This clearly shows there is scope to revive demand without stoking inflation, said Rajan.

At the same time, inflation has remained under control and is expected to reach 5.8% in January, a shade lower than the August projection of 6%, Rajan said.

Inflation measured by the consumer price index in August eased to a record low of 3.66% from a revised 3.69% in July, helped partly by low commodity prices that have curbed imported inflation.

Asked whether the central bank’s outlook was hawkish and the policy statement itself was dovish, Rajan joked: “My name is Raghuram Rajan and I do what I do."

Rajan said RBI will be working with the government to help banks reduce their lending rates faster. While RBI will be checking its own regulations, including how the base rate is calculated, and will ensure liquidity in the banking system is plentiful, if not surplus, the government will also work towards reforming interest rates on small savings schemes.

Banks have said in the past they cannot lower their deposit rates below small savings schemes of the government as that would hurt loyal bank depositors.

Jaitley said the government will review small savings interest rates but refused to give a timeline for it.

State Bank of India’s chief economist Soumya Kanti Ghosh said even after the higher-than-expected rate reduction, RBI still has room for another 25 basis points rate cut in this fiscal and may offer another reduction if the inflation trajectory remains on the lines expected by the central bank.

On Tuesday, RBI kept the cash reserve ratio, or the portion of deposits that banks must set aside with the central bank, unchanged at 4%.

RBI also lowered its growth forecast marginally and said inflation will likely see some uptick from September because of the base effect.

“With global growth and trade slower than initial expectations, a continuing lack of appetite for new investment in the private sector, the constraint imposed by stressed assets on bank lending and waning business confidence, output growth projected for 2015-16 is marked down slightly to 7.4% from 7.6% earlier," RBI’s policy document said.

In its policy, the central bank also reduced the risk weights applicable to lower-value but well collateralized individual housing loans. This will help banks lend more to affordable, low-cost housing and will give a fillip to the government’s “housing for all" programme, RBI said.

Interacting with the media after the policy, bankers said a large part of the policy rates would eventually get transmitted.

“Clearly interest rates will come down, base rates will come down and a large part of the cut will get transmitted. When I say a large part will be transmitted, it should mean that more than half should happen," said Chanda Kochhar, managing director and chief executive officer of ICICI Bank Ltd.

The rupee closed trading at 65.96, up 0.14% from its previous close of 66.05. The unit opened at 66.33 per US dollar and touched a low of 66.42 before policy announcement.

The BSE’s benchmark Sensex index rose 161.82 points, or 0.63%, to close at 25,778.66. The index was trading 300 points down before the policy announcement.

The yield on India’s 10-year benchmark fell to 7.611% compared with its Monday close of 7.727%. Bond yields and prices move in opposite directions.

Asit Ranjan Mishra in New Delhi contributed to this story.

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