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Reserve Bank cuts repo rate by 25 basis points

March 4: Reserve Bank of India Governor Raghuram Rajan has brought down its key policy rate by 25 basis points, citing that the fiscal consolidation was better than what numbers show and that the combined fiscal deficit is much lower due to the government transferring more funds to the states.

"The true quantum of fiscal consolidation may be higher than in the headline numbers. Also, the government is transferring a significantly larger amount to the states, without entirely devolving responsibility, for funding central programmes. To the extent that the state budget deficits narrow, the general fiscal deficit will be lower," Rajan said in a statement.

"It has been decided to reduce the policy repo rate under the liquidity adjustment facility by 25 basis points from 7.75% to 7.5% with immediate effect," the statement said.

The move comes less than a week after the Union Budget where Finance Minister Arun Jaitley announced the signing of a monetary policy framework where RBI has been given a flexible inflation target of 4% in the medium term. The government also said that it will amend the RBI act to set up a monetary policy committee which will henceforth decide on policy rates.

This is the first time that the Reserve Bank of India has announced a monetary policy action ahead of markets opening. Following the move, shares of public sector banks traded up as they are expected to generate higher profit from sales of government bonds.

On the inflation target which is the main agenda of the government, Rajan said "To summarise, softer readings on inflation are expected to come in through the first half of 2015-16 before firming up to below 6% in the second half. The fiscal consolidation programme, while delayed, may compensate in quality, especially if state governments are cooperative. Given the 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 said.