The Reserve Bank of India (RBI) surprised the markets by cutting the repo rate by 50bps (basis points) on Tuesday. Markets had expected the central bank to reduce the rate by 25bps.
With the latest cut, the RBI has slashed the repo rate by 125bps to 6.75% so far this year. The central bank, however, kept the cash reserve ratio (CRR) unchanged at 4%.
Reacting to the rate cut, the domestic stock markets posted a quick recovery, with the benchmark BSE Sensex paring all the losses witnessed in the early trading session.
"The RBI has given a positive surprise to the markets, by cutting repo rate by 50bps, as against expectations of 25bps cut. Inflation has been well under control with CPI below 4%, creating a good window to cut rates, before some seasonal uptick in coming months from potentially higher food prices (ex-cereals) due to deficit monsoons," said Dinesh Thakkar, CMD of Angel Broking, in a note.
The central bank said that most of the conditions for additional easing have been met. The retail inflation fell to a record low of 3.66% in August, while the wholesale price index (WPI) remained in negative for a tenth straight month.
Further, the rate cut action by the RBI seems to have prompted by a slowing economic growth, which fell to 7% in the first quarter of the current fiscal year. Recently, some foreign brokerages have downgraded their forecast for India's growth following the weak monsoon and the government's failure to pass key reform bills.
The RBI also revised down its forecast for India's gross domestic product (GDP) growth to 7.4% for the fiscal year 2015-16.
Further, a deficient monsoon rainfall is expected to hike the food prices, leading to a spike in inflation in the coming months. A rise in inflation is likely to curtail the scope of further rate cuts by the RBI.
"We think that today's larger-than-expected rate cut will mark the end of the easing cycle," said Capital Economics in a note.