India central bank surprises with unscheduled rate cut

The Reserve Bank of India (RBI) on Thursday surprised markets by cutting interest rates, in a bid to spur growth in Asia's third-largest economy and on the back of evidence that inflation has slowed.

The central bank cut its key repo rate by 25 basis points to 7.75 percent, its first cut since March 2013. The RBI was not scheduled to meet on monetary policy until February 3.

The move comes a day after government data showed wholesale price inflation in December rising 0.11 percent from the year-ago period, much lower than the 0.6 percent rise forecast by economists, as oil prices plunged and food costs stabilized.

In a statement, the RBI cited lower-than-expected inflation, weak crude prices and weak demand as the reasons for its move, as well as the government's commitment to sticking to a fiscal deficit target. "These developments have provided headroom for a shift in the monetary policy stance," it said.

Markets reacted with euphoria on the news: the rupee strengthened to as much as 61.70 against the U.S. dollar, from a close of 62.09 on Wednesday. The benchmark stock index Sensex jumped 2 percent in the early going.

Raghuram Rajan, The Reserve Bank of India (RBI) Governor.
Danish Siddiqui | Reuters
Raghuram Rajan, The Reserve Bank of India (RBI) Governor.

"The timing of the RBI's decision to lower rates comes as a surprise," Radhika Rao, economist of at DBS, told CNBC. "They [RBI policymakers] had flagged the possibility of an inter-meeting cut back in December, but have front-run market expectations."

"This demonstrates their confidence on the evolving inflation outlook, much due to the way global commodity prices are shaping up. Simultaneously, the RBI has also put their faith in the government's fiscal consolidation efforts and that adequate corrective steps this quarter will keep targets in check," she added.

To be sure, the move was not an entire surprise to some, as RBI governor Raghuram Rajan had previously indicated that the central bank could move outside the regular policy meetings should the need arise.

"It shows RBI means business," said Mitul Kotecha, head of FX strategy, Asia Pacific at Barclays. "It tells you that inflation is moving in the right direction to the point that disinflation is at a much faster pace than anticipated by RBI. It is good news hence the inter-meeting cut."

Market watchers say the stage is now set for a new round of easing cycle going into the next financial year.

"Today's cut possibly paves the way for another 50 basis points heading into financial year 2015/2016, provided the pre-conditions of quality fiscal correction and waning inflation risks hold," said DBS's Rao.

"I think this is very important for rate cycle change and we expect more to come," added Hiroshi Yoh, CEO and portfolio manager and Janus Capital Singapore, "But they will likely take place in the second half of 2015 versus first half as we are still waiting for the interest rate hike in the United States. India remains worried about capital flight when the U.S. changes [monetary] policy."

Will it make a difference?

Jahangir Aziz, head of EM Asia economic research at JP Morgan, says while the RBI's move may provide fresh impetus to equity markets, it's unlikely to move the needle on corporate investment.

"I don't think corporates haven't been investing because they were waiting for a 25 basis point rate cut or 100 basis point rate cut for that matter," he said.

More importantly,corporates are awaiting clarity around several government policies ranging from the land-acquisition act to environmental laws before they commit to expansion plans, Aziz noted.

— CNBC's Ansuya Harjani contributed to the report.