The Reserve Bank of India (RBI) on Tuesday cut its policy interest rate by an expected 25 basis points, bringing it to 6.5%, the lowest since January 2011.
The RBI also introduced a host of measures to smoothen liquidity supply so banks can lend to productive sectors.
The cut was broadly in line with expectations. However, the stock market reacted negatively and the BSE index, Sensex, was down nearly 300 points.
Given weak private investment in the face of low capacity utilisation, a reduction in the policy rate by 0.25 per cent will help strengthen growth, RBI Governor Raghuram Rajan said in the first bi-monthly monetary policy review for the 2016-17 fiscal, which began on April 1.
Rajan also took a host of measures on the liquidity front, starting with the narrowing of the policy rate corridor to 0.50 per cent from the earlier 1 percentage point, which resulted in the reverse repo rate – at which banks can park excess funds with the RBI – being reset at 6 per cent.
The policy said the average overnight borrowings by banks have increased to Rs 1,935 billion in march from Rs 1,345 billion in January.
Stating that the inflation objectives are closer to being realised and price-rise will hover around the 5 per cent mark for the remainder of the fiscal, Rajan reaffirmed that the monetary policy will continue to remain accommodative to address the growth concerns.
RBI also retained its GDP growth forecast at 7.6 per cent, on the assumption of a normal monsoon and a boost to consumption through the implementation of the Seventh Pay panel recommendations.
The central bank said it expects the implementation to hurt inflation by 1-1.5 per cent over a two year period, but added that the shock will not be as strong as that felt during the implementation of the sixth pay panel suggestions.
Rajan welcomed the government move to amend the RBI Act to create a monetary policy committee, saying it will further strengthen the policy s credibility.
He also welcomed the government’s adherence to the path of fiscal consolidation, calling it as a commendable commitment this will support the disinflation process going forward.
“We see inflation slowing modestly and remaining around 5% for fiscal year 2017 with small inter-quarter variations,” RBI governor Raghuram Rajan said. The RBI also sees an impact of the seventh pay commission on inflation, at 100-150 bps over the next two years.
The RBI retained the growth forecast of 7.6% in fiscal 2017.
It also increased the reverse repo rate by 25 basis points to 6% on account of new rate corridor and kept the cash reserve ratio unchanged at 4%.
With inflation easing to 5.18% in February and a central budget that kept both borrowing and spending in check, the RBI had room to make its first cut since September, thus resuming an easing cycle that was in full swing last year.
Last year, the RBI had reduced the repo rate by 125 basis points (bps) in total, but it had been frustrated by commercial banks’ failure to pass on the full benefits of the reduced rate to the wider economy.