In a surprise move, the Reserve Bank of India (RBI) cut its main lending rate--the repo rate --by 0.25 percentage points to 7.5% on Wednesday morning rekindling hopes of lower EMIs for homeloan borrowers and cheaper bank capital for companies to aid their expansion plans.
This is the second rate cut by RBI in the last three months amid benign inflation rates. While wholesale inflation was (-)0.4 % in January, retail inflation was 5.11 % --much lower than the target of 6% by January 2016.
"Given low capacity utilisation and still-weak indicators of production and credit off-take, it is appropriate for the Reserve Bank to be pre-emptive in its policy action to utilise available space for monetary accommodation," RBI governor Raghuram Rajan said in a statement.
Immediately after the announcement, markets welcomed the move, with the BSE Sensex jumping over 430 points to cross the 30,000 mark for the first time ever.
The rupee strengthened by 27 paise to trade at 61.65 against the dollar in early trade today at the Interbank Foreign Exchange
The RBI uses monetary tools to stymie demand and cool prices. In times of weak growth and low prices, it is usually expected that the central bank will cut interest rates to goad companies to invest, add capacities, hire more, and prompt people to spend on houses, cars and other goods.
The rate cut comes four days after the presentation of the budget for 2015-16 and two days after the government and the Reserve Bank of India (RBI) announced that they have agreed to adopt a monetary policy framework, which will make taming inflation the primary priority of the central bank’s policy decisions.
Under the new system, billed as biggest monetary reform measure in a generation, the RBI will set a new retail inflation target of below 6% by January 2016 and 4% by March 2017.
The framework also will empower the RBI governor to decide the most appropriate measures needed to achieve that target.
This approach now become standard international practice in many mature economies, such as Britain, where the central bank sets interest rates and other monetary tools according to an inflation target set by the government.
The new framework will remove speculation ambiguities in the way RBI’s decisions on interest rates.