02/06/2015 11:58 AM IST | Updated 15/07/2016 8:25 AM IST

Reserve Bank Cuts Key Lending Rate To 7.25 Percent; Banks Likely To Follow

PUNIT PARANJPE via Getty Images
Reserve Bank of India (RBI) governor Raghuram Rajan speaks during a news conference at the RBI headquarters in Mumbai on December 2, 2014. India's central bank kept interest rates unchanged on December 2 despite growing calls to ease monetary policy, saying a reduction would be 'premature'. AFP PHOTO/ PUNIT PARANJPE (Photo credit should read PUNIT PARANJPE/AFP/Getty Images)

The Reserve Bank of India cut the benchmark repo rate by 25 basis points to 7.25 percent, and raised its forecast for inflation next year.

"This was the most we could do given the data we had," said governor Raghuram Rajan at a press conference following the review meeting. "We have to be on a disinflationary path, and we will use any room that opens up on that path."

The rate cut is in keeping with analyst expectations in various polls. This was the third cut this year, and of the same extent as the previous two.

Rajan cited weaker inflation and mixed indicators of recovery. He further said that future rate cuts depend on the economy, which currently shows inflationary risks. "Below normal monsoon has been predicted, and food prices are firming amidst volatility in the external environment," Rajan said. "We will wait to see the government response if the monsoon is weak."

The bank's cautious stance on future cuts led to a sharp drop in the Nifty, which shed as much as 1.1 percent after the announcement.

The RBI also said it now expects inflation to touch 6 percent by January next year. He said the bank was working with the government to reduce bottlenecks in the path to growth. "We play together. These cuts will ease the way for further investments," he said.

Consumer price inflation fell to 4.8 percent in April, the lowest in four months. RBI has a CPI inflation target of 6 percent for the current year and aims to bring down inflation to 4% in the medium term.

It took until April for businesses and individuals to benefit from the first two rate cuts because banks, straddled with low liquidity, were reluctant to lend. Rajan had admonished them for that, saying that "credit growth is tepid, banks are sitting on money and their marginal cost of funding has fallen. The notion that it hasn't is nonsense." Since then, major banks such as State Bank of India, HDFC Bank and ICICI Bank have cut rates.

This time, banks might respond faster. “Banks can be expected to reduce their base rates by 25 basis points simply because this is a lean season and credit growth is weak so there is no pressure on bank earnings,” said Indranil Sengupta, chief India economist at Bank of America-Merrill Lynch in this report.

Contact HuffPost India