NEW DELHI: “The Reserve Bank of India (RBI) on Tuesday cut the short-term lending rate, or repo rate, by 25 basis points to 6.25 per cent from 6.50 per cent earlier.

The fresh repo rate cut has resulted in a cumulative 175 basis points drop in policy rate since January 2015.

This was the first exercise by the monetary policy committee (MPC), chaired by Governor Urjit Patel. All the six committee members voted in favour of the monetary policy decision. The minutes of the MPC’s meeting will be published on October 18.

The policy rate in India has averaged 6.70 per cent from 2000 until 2016. MPC noted that the recent sharp drop in inflation reflects a downward shift in the momentum of food inflation – which holds the key to future inflation outcomes – rather than merely the statistical effects of a favourable base effect.

A total of 14 of the 18 banks and financial institutions polled by ET last week were expecting RBI to cut policy rate. The announcement has come in the wake of the recent easing of inflation within RBI’s comfort zone of 4 per cent, plus/minus 2 per cent.

Retail inflation, a key factor that the central bank considers before deciding policy rates, stood at 5.05 per cent in August, the lowest in six months.

“The committee expects that the strong improvement in sowing, along with supply management measures, will improve the food inflation outlook. It notes that the sharp drop in inflation reflects a downward shift in the momentum of food inflation – which holds the key to future inflation outcomes – rather than merely the statistical effects of a favourable base effect,” said RBI in a statement.

The central bank has maintained status quo on cash reserve ratio (CRR), which stands at 4 per cent while statutory liquidity ratio (SLR) remained unchanged at 20.75 per cent. The marginal Standing Facility (MSF) rate, meanwhile, has been adjusted to 6.75 per cent from 7 per cent earlier.

Following the development the BSE Sensex, which was trading flat, spiked over 100 points. However, the index could not hold the gains and soon retreated. Sensex closed the day at 28,334, up 91 points, or 0.32 per cent. The Nifty50 reclaimed 8,750 level to eventually end the day at 8,769.

Ajay Bodke, CEO and Chief Portfolio Manager for PMS at Prabhudas Lilladher, said he expects the policy rate to come down by at least 50 basis points over the next six months.

Radhika Rao, India Economist at DBS, said given that India would see FCNR redemptions in October-November, the forthcoming US election and a possible Fed rate hike in December, Tuesday was the best chance for RBI to move on policy rate.

“The central bank had room to cut rates, even if these kinds of risks are in the horizon. I think the differentials are still pretty much in our favour,” Rao had said.
Interest-sensitive stocks from banking, auto and real estate and shares of consumption-related stocks jumped following the announcement.

The RBI retained its real gross value added (GVA) forecast for 2016-17 at 7.6 per cent, saying risks are evenly balanced around it.

The next meeting of the MPC is scheduled on December 6 and 7, 2016 and its resolution will be announced on December 7.

This article is originally posted on Economics Times