MUMBAI (Bloomberg) - India's central bank lowered interest rates for a third time this year to spur private investment, and said it'd wait to assess monsoon rains before acting again.
Governor Raghuram Rajan cut the benchmark repurchase rate to 7.25 per cent from 7.5 per cent, the Reserve Bank of India said in a statement in Mumbai on Tuesday. The move, which takes the rate to the lowest since September 2013, was predicted by 33 of 41 economists in a Bloomberg News survey. Seven saw no change and one expected a 50 basis-point cut.
While "a conservative strategy would be to wait" for more certainty on how monsoon rains will affect inflation, weak investment means "a more appropriate stance is to front-load a rate cut today and then wait for data that clarify uncertainty," Rajan said. "Meanwhile banks should pass through the sequence of rate cuts into lending rates."
The move follows China's cuts and comes just months before an expected increase in U.S. interest rates that risks triggering outflows from emerging markets. Room to ease policy may reduce if oil prices continue rising and monsoon rains are less than normal.
"There's this need to utilize the current window of low inflation and to ease rates to support what is still a weak recovery," Devika Mehndiratta, an economist at ANZ Banking Corp. in Singapore, said by phone before the decision. "Later it might not be timely enough."
Consumer prices rose 4.87 per cent in April from a year earlier, holding below Rajan's 6 per cent target for an eighth straight month. While price pressures have so far proved immune to crop damage from unseasonal rains, the weather department predicts monsoon rainfall - which waters more than half of India's farmland - will be below average this year.
Rajan said three risks are clouding the inflation outlook: the possibility of a weak monsoon, rising oil prices and a volatile external environment. Consumer prices are likely to fall until August and then start rising to about 6 percent by January 2016, Rajan said.
"The risks to the central trajectory are tilted to the upside," he said. He called for strong food policy and management to keep inflation contained in the near term, while saying a rate cut will facilitate public investment that eases supply constraints and reduces inflation over the medium term.
Rajan also said a targeted infusion of bank capital into state-run commercial banks is warranted so that adequate credit flows to productive sectors.
Since food prices account for almost 50 per cent of India's CPI basket, Rajan has little scope to reduce interest rates if they aren't contained. He's also bound by a mandate to lower inflation to around 4 per cent in the next few years.
Swap traders were betting before the decision that India will cut the key rate to 7 per cent by year's end, the steepest decrease after Turkey among 14 emerging markets tracked by HSBC. The rupee has fallen about 1 per cent this year.
It's crucial for Rajan to gauge the strength of India's economy. While gross domestic product expanded 7.5 per cent in the first three months of the year, gross value added - a component of GDP watched closely by the central bank - gained 6.1 per cent versus an estimated 7 per cent.
Rajan cut the central bank's projection for output growth in the year through March 2016 to 7.6 per cent from 7.8 per cent earlier.
The latest government data show exports dropped for a fifth straight month, factory output slowed to a five-month low and bad loans at banks are estimated to rise to the highest since 2001. Domestic vehicle sales rose 1.9 per cent in April compared with a 7 per cent increase a year earlier.
"In the here and now, the Indian economy remains sluggish," Richard Iley, an economist at BNP Paribas SA, wrote in a May 27 report.
