<div>The Reserve Bank of India (RBI) surprised markets with a 25 basis point reduction in interest rates and signalled it could cut further, amid signs of cooling inflation and what it said was a government commitment to contain the fiscal deficit. Displaying the pragmatism and flexibility, RBI Governor Raghuram Rajan's surprise move gave a boost to the government's efforts to revive growth.<br /><br />By explicitly tying future rate cuts to "high quality fiscal consolidation", the former IMF chief economist has put the ball back in Prime Minister Narendra <br /><br />Modi's court while showing enough independence to preserve his credibility with markets.<br /><br />Within hours of rate cut announced by RBI, United Bank has reduced the benchmark lending rate by 0.25 per cent, while other banks including market leader SBI have indicated that they would follow suit (<span style="color: rgb(255, 0, 0);"><strong>Read Also</strong></span><strong>: <a href="http://www.businessworld.in/news/finance/banking/banks-start-cutting-lending-rates/1700720/page-1.html">Banks Pass On Rate Cut</a></strong>). EMIs for home, auto and other loans will come down with the reduction in base rate or the minimum lending rate which, in turn, will boost demand and propel growth in the manufacturing sector.<br /><br />The <a href="http://www.businessworld.in/news/finance/markets/sensex-marks-biggest-daily-gain-in-8-months/1700781/page-1.html"><strong>BSE Sensex and Nifty rose more than 2.5 per cent</strong></a> on Thursday (15 January), marking their biggest daily gain in eight months, after blue-chips led by interest rate-sensitive stocks surged on hopes the central bank's surprise rate cut will stoke growth. The Sensex rose as much as 3.1 percent during the day before ending 2.66 percent higher. The broader Nifty ended up 2.62 percent after earlier rising as much as 3 percent.<br /><br />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.<br /><br />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.<br /><br /> </div><table width="200" cellspacing="1" cellpadding="1" border="1" align="right"><tbody><tr><td style="text-align: center;"><span style="color: rgb(255, 0, 0);"><strong>Message To Modi: Now Fix The Budget</strong></span></td></tr><tr><td><img width="200" height="200" align="middle" src="/image/image_gallery?uuid=5732112b-5e6c-4f68-a13c-1a10b82c1d67&groupId=36166&t=1421321426072" alt="" /><br /><br /><span style="color: rgb(102, 102, 153);"><strong>Rajan's surprise quarter-point cut not only acknowledges that inflation is easing sharply, but also marks a concession to a government that has repeatedly, if politely, demanded monetary policy relief.<br /><br />By explicitly tying future rate cuts to "high quality fiscal consolidation", the former IMF chief economist has put the ball back in Prime Minister Narendra Modi's court while showing enough independence to preserve his credibility with markets.<br /><br />Modi's finance minister, Arun Jaitley, now needs to deliver cuts in subsidies, boost tax revenues and invest more in India's rotten infrastructure when he presents his first full-year budget to parliament next month.</strong></span><br /> </td></tr></tbody></table><div>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.<br /><br />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.<br /><br />"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.<br /><br />The Reserve Bank of India's unexpected 25 basis points rate cut does not change the country's sovereign credit profile, an analyst at Fitch Ratings told Reuters on Thursday.<br /><br />Instead, Thomas Rookmaaker, a director at Fitch in Hong Kong, said government fiscal consolidation and the creation of a "credible low inflation environment" were more important factors.<br /><br />"The fiscal position is a long-standing key weakness in India's sovereign credit profile and, hence, fiscal consolidation that would bring down the high public debt burden would improve the sovereign credit profile," Rookmaaker wrote in an emailed reply to questions from Reuters.<br /><br />"It will be interesting to see if the budget will include a clear and credible strategy to improve the fiscal position."<br /><br /><strong>Start Of A New Easing Cycle</strong><br />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.<br /><br />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.<br /><br />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.<br /><br />In its statement, the RBI said "high quality" fiscal consolidation and reforms to power, land, minerals and infrastructure would be "critical" to more cuts.<br /><br />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.<br /><br />India has posted sub-5 per cent growth rates in its previous two financial years, levels far too slow for a country with its demographic challenges.<br /><br /><strong>Subsiding Inflation Pressure</strong><br />Data released on Monday showed retail inflation rose to 5 per cent in December -- below the 5.4 per cent annual rise predicted by a Reuters poll. The RBI expects retail inflation will hit 6 per cent in March and targets a level of below that from January next year.<br /><br />Some analysts believe Rajan may have come under pressure from the government to lower interest rates sooner than he would have ideally chosen.<br /><br />"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.<br /><br />"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."<br /><br />Key for markets now will be how quickly the effect of Thursday's cut can boost consumption and investment.<br /><br />The rate cut pushed the benchmark 10-year bond yield to 7.65 per cent, 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 per cent.<br /><br />In the overnight indexed swap market, the one-year rate dropped as much as 13 bps to 7.50 per cent, its lowest since July 15, 2013, which traders said priced in an additional 100 bps in rate cuts.<br /> </div>
