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India cuts interest rates by more than expected

36India’s central bank has cut its key interest rate for the fourth time this year, and by more than expected.
The Reserve Bank of India (RBI) reduced its repo rate to 6.75% from 7.25%, with economists having forecast it would trim rates to 7%.
The repo rate is the level at which the central bank lends to commercial banks.
The bank has been under pressure to boost growth after inflation hit a record low of 3.6% in August due to falling commodity prices.
The latest cut takes interest rates in the country to the lowest level in four and a half years.
The RBI had already cut the policy rate by a total of 75 basis points this year, following rate reductions in January, February and June, on the back of low inflation.
“In India, a tentative economic recovery is underway, but is still far from robust,” RBI governor Raghuram Rajan said in a statement.
“Investment is likely to respond more strongly (and boost domestic demand) if there is more certainty about the extent of monetary stimulus in the pipeline.”
This size of the rate cut is a bit of surprise – so was it pressure or pragmatism that led to the 50 basis point cut?
I’d argue that central bank governor Raghuram Rajan decided this was the best window to lower rates this year.
If this year’s lower-than-average rainfall leads to poor harvests and higher inflation – then making a rate cut later would have been be tough.
Also, Mr Rajan surely has one eye on US Federal Reserve.
If, as many expect, the Fed moves to raise interest rates by the end of the year – money is expected to start flowing out of emerging economies like India.
And that will definitely make it tough for the RBI to cut rates further.
Growth concerns
Economic growth in India, Asia’s third largest economy, slowed to an annual rate of 7% between April and June, down from 7.5% in the previous quarter.
Consumer inflation is also well below the central bank’s target of 6% for January next year.
Atsi Sheth of Moody’s Investors Service said the extent of the rate cut suggested the central bank thought underlying growth was still subdued.
“It also suggests that inflation is not the key risk at this time, in the RBI’s view,” he told Reuters.
Shilan Shah, an economist at Capital Economics, added that the latest cut implied the central bank might have reached a “turning point”, marking the end of its easing cycle.
“The accompanying statement appears to suggest that the RBI is passing the mantle on to the government and banking sector to drive a sustained economic recovery,” he said in a note.
Indian shares reversed losses after the central bank’s decision, with the benchmark BSE index trading flat at 25,607.93. The index had been more than 1% lower earlier in the session