It marked the first interest rate decision under new bank chief Shaktikanta Das, an ally of Modi who was appointed in December after his predecessor, Urjit Patel, quit following a public spat with the administration over alleged government interference.
The Reserve Bank of India (RBI) announced a surprise 25 basis points (bps) cut in the benchmark lending rate to 6.25 per cent Thursday, a move that will be welcomed by the poll-bound Modi government.
The repo rate cut, coming after a gap of 18 months, will nudge banks to cut interest rates on loans for borrowers and provide a stimulus for demand in the economy. In its budget on Feb 1, the government doled out cash to farmers and tax cuts to middle-class families, at the cost of a wider fiscal deficit and larger borrowing. The RBI MPC also chose to change the monetary policy stance from calibrated tightening to neutral.
Gaurav Dua, Head of Research at Sharekhan by BNP Paribas, said the change in stance to "Neutral" and dovish commentary open doors for further rate cuts going ahead.
Das also downplayed the risk of inflation rising due to the forecast of fiscal slippage in last week's budget, and said the MPC will only look at the headline inflation number and ignore core inflation that has proven sticky.
India's retail inflation declined from 3.4 per cent in October 2018 to 2.2 per cent in December, well below the bank's target of four percent.
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"Headline inflation is projected to remain soft in the near term reflecting the current low level of inflation and the benign food inflation outlook", the statement said, but cautioned that beyond the near term, some uncertainties warrant careful monitoring such as volatile vegetable prices, crude oil prices and trade tensions.
Deputy Governor Viral Acharya and another MPC member, Chetan Ghate, voted for status quo in interest rates, while Das and three others voted for a cut in interest rates.
Statistics showed the economy expanded only 7.1 per cent on-year in July-September, down from 8.2 percent in the previous quarter.
In a tweet, Economic Affairs Secretary Subhash Chandra Garg welcomed the rate cut and stance change, saying the MPC had come up with a "balanced and pragmatic policy statement".
The Reserve Bank of India (RBI) on Thursday retained the country's gross domestic product (GDP) forecast for FY20 at 7.4 per cent. Addressing the media on Monetary Policy, RBI Governor Shaktikanta Das said GDP projection for 2019-20 is 7.4 per cent while the inflation rate is estimated at 3.2-3.4 per cent in the first half of the year 2019-20 and 3.9 per cent in the third quarter of 2019-20. "Both recent history and forward guidance make a compelling case for the rate cut".
The rupee weakened to 71.69 to the dollar immediately after the announced but strengthened soon after to 71.42.