Dr.Raghuram Rajan, RBI Director

As India prepared to celebrate the movement of the Sun into the Makara (Capricorn) zodiac sign, signalling the beginning of the harvest season and the arrival of spring, the Reserve Bank of India cut its repo rate by 25 basis points, bringing cheer to the stock market.

In a surprise move the RBI brought down the lending rate to 7.75% from 8%, the first reduction in almost a year.

RBI issued a statement saying the cut in interest rate was helped by lower-than-expected inflation, weak crude prices and a weak demand. It also commended the government on its commitment to stick to the planned fiscal deficit.

"These developments have provided headroom for a shift in the monetary policy stance," RBI Governor Raghuram Rajan noted.

The unexpected rate cut sent the stock markets into frenzy, with the Sensex hitting a day's high of 27947.59, before settling down to trade at 27346.82, up by 427.01 points or 1.56%.

RBI also noted that further cut to the interest rate is possible if the inflation continues to ease, while it continues to monitor the government's progress on fiscal consolidation.

The fall in global oil prices helped India's wholesale price index for December to increase by just 0.11% on a year-on-year basis.

However, retail inflation increased to 5% in December, even as economists polled by Reuters, had expected a 5.4% annual rise. The RBI's target for the year is to limit the inflation to 6%.

The move comes ahead of RBI policy meeting on 3 February and the government's annual budget statement scheduled for the last week of February.

The rate cut is seen as an harbinger of hope for the Indian economy, which is currently stuck in the slowest growth phase since the 1980s. The Narendra Modi government has implemented significant reforms, even as the finance ministry, industry bodies and the banking sector have long clamoured for a rate cut.

The current cut, though not significant, boosts hopes of more aggressive reductions in rate through the course of the year. As the benefits of the reforms kick in, the economy is expected to move into a higher growth phase of 6-7%.

The Finance Ministry said it had no immediate comment on the move, but would issue a statement soon.