RBI makes surprise early rate cut, hints at more

By Clara Ferreira-Marques and Rafael Nam MUMBAI (Reuters) - The Reserve Bank of India (RBI) surprised markets with a 25 basis point reduction in interest rates on Thursday and signalled it could cut further, amid signs of cooling inflation and what it said was a government commitment to contain the fiscal deficit. While the early move was unexpected, aggressive reductions in rates have been seen as likely over the course of the coming year to help India's economy out of a rut, with growth rates struggling to recover from their weakest levels since the 1980s. (Click http://in.reuters.com/article/2015/01/15/india-rbi-repo-idINKBN0KO09020150115 to read what experts say about the RBI's rate move) Tumbling oil prices and lower food costs have hardened speculation that more reductions in rates will follow, as recent data showed subdued consumer and wholesale price increases. Acting ahead of a scheduled RBI policy meeting on Feb. 3 and the government's annual budget statement in late February, the RBI cut the repo rate - its key lending rate - to 7.75 percent from 8.0 percent, where it had been for the past year. As a result, the reverse repo rate, the rate at which the central bank drains excess liquidity from the banking system, also moved down by 25 basis points to 6.75 percent. "This demonstrates RBI’s confidence in the evolving inflation outlook and it shows that they are putting faith in government's fiscal consolidation plan," said Radhika Rao, economist at DBS Bank Ltd. Investors saw RBI Governor Raghuram Rajan putting India on a new easing cycle, as the former International Monetary Fund chief economist ordered his first rate cut since being appointed in August 2013. (For full coverage of RBI's rate decision, click http://in.reuters.com/subjects/rbi-policy-review) Finance Minister Arun Jaitley, who earlier this week had said the time was right for lower rates, welcomed the cut and said it would help revive capital investments. The early rate reduction now puts the onus on the government to make credible efforts to contain the fiscal deficit while pursuing policies aimed at boosting investment and improving infrastructure to fire up the economy. In its statement, the RBI said "high quality" fiscal consolidation and reforms to power, land, minerals and infrastructure would be "critical" to more cuts. India's stock market was the second best performer in Asia last year in dollar terms, due to investors' hopes that Prime Minister Narendra Modi would push reforms needed to unlock India's growth potential following his landslide election last May. India has posted sub-5 percent growth rates in its previous two financial years, levels far too slow for a country with its demographic challenges. SUBSIDING INFLATION PRESSURES Data released on Monday showed retail inflation rose to 5 percent in December -- below the 5.4 percent annual rise predicted by a Reuters poll. The RBI expects retail inflation will hit 6 percent in March and targets a level of below that from January next year. Some analysts believe Rajan may have come under pressure from the government to lower interest rates sooner than he would have ideally chosen. "This is a surprise move in the middle of the war on inflation," said N.R. Bhanumurthy, a New Delhi-based economist at the National Institute of Public Finance and Policy. "I am very surprised because it goes against the whole current governor’s philosophy that monetary policy should be predictable. It shows the governor is very pragmatic and can look at his own position and can change." Key for markets now will be how quickly the effect of Thursday's cut can boost consumption and investment. The rate cut pushed the benchmark 10-year bond yield to 7.65 percent, down 12 basis points on the day and its lowest level since July 15, 2013, while stocks rallied, with the Nifty gaining some 2.5 percent. In the overnight indexed swap market, the one-year rate dropped as much as 13 bps to 7.50 percent, its lowest since July 15, 2013, which traders said priced in an additional 100 bps in rate cuts. The partially convertible rupee gained to as much as 61.6450, its strongest level since Nov. 17. Banks are likely to lower lending rates as a result of the RBI action, but company bosses warned a 25 basis point rate cut would not by itself get the economy growing, with many manufacturers running with high levels of spare capacity. "The real effect at 25 bps is not going to be very much, however, it is the start of a cycle," said VS Parthasarathy, chief financial officer at Mahindra & Mahindra , India's top utility vehicle maker. "Sometimes a stimulus is all about giving a cue... this is a cue." (Additional reporting by Andrew MacAskill in NEW DELHI, Suvashree Dey Choudhury and Aman Shah in MUMBAI; Editing by Douglas Busvine and Simon Cameron-Moore)