India's central bank cut its benchmark repo rate by 25 basis points to 6.0 percent, as widely expected, but retained a neutral monetary policy stance as inflation is still projected to rise from a historic low in June.
It is the first rate cut by the Reserve Bank of India (RBI) since October 2016 and the seventh cut since the RBI began on an easing cycle in January 2015. Since then key rates have been cut by 200 basis points.
While the outlook for India's agricultural sector "appears robust," growth in industry and services was weakening due to corporate deleveraging and a retrenchment of investment demand, opening up some space for monetary policy accommodation.
But RBI underscored that it remains focused on keeping inflation close to its 4 percent target and will "continue monitoring movements in inflation to ascertain if recent soft readings are transient or if a more durable disinflation is underway."
For the second time since setting up its monetary policy committee in October last year, the committee was split in its policy decision. Four of its members, including Governor Urjit Patel, were in favor of a 25-basis-point cut, Ravindra Dholakia was in favor of a 50-point cut while Michael Debabrata Patra voted for status quo.
Prior to last year, the RBI's rate decisions were taken solely by its governor but in an major shift as part of a move to inflation targeting, the bank set up a monetary policy committee to set rates, with three members appointed by the RBI and the other three by the government.
India's consumer price inflation rate fell to 1.54 percent in June from 2.99 percent in May, the lowest since the current inflation series was begun in 2011/12, mainly due to favorable base effects that will disappear and reverse from August, RBI said.
Prices of food and beverages, which fell in May, sank further in June as fuel inflation declined for the second month in a row on lower LPG prices and lower increases of other fuel prices.
But administered prices of LPG and kerosene are set to rise as subsidies are trimmed and the RBI said households appeared to have discounted the low inflation as their expectations "somewhat hardened" in the June survey.
Other factors influencing future inflation are the implementation of farm loan waivers by states, which may result in fiscal slippage, and the timing of states' salary awards, which could push up inflation by an additional 100 basis points over the next 18-24 months.
The fall in inflation was largely in line with the RBI's projections from June in which inflation was seen averaging 2.0 to 3.5 percent in the first half of 2017/18, which began April 1, and between 3.5 and 4.5 percent in the second half.
India's economy slowed in the first quarter of calendar 2017 to annual growth of 6.1 percent, down from 7.0 percent in the previous quarter and the RBI said business sentiment in manufacturing reflected expectations of a moderation of activity in the third calendar quarter, with high levels of stress in banks' and corporations' balance sheets likely to deter new investment.
At the same time, the likelihood of another good kharif harvest is rising, rural demand may benefit from spending on housing, higher budgets for roads and buildings, spurring investment.
And while external demand is gradually improving, global political risks remain significant, the RBI said, maintaining its forecast for economic growth for 2017-18 at 7.3 percent, with risks evenly balanced.
After depreciating steadily since May 2014 to historic lows of 68.8 to the U.S. dollar in the wake of the election of U.S. President Donald Trump in November 2016, the rupee has been gaining strength slowly and rose further following the rate cut to 63.6 from 64.1 to be up almost 7 percent this year.
