The Reserve Bank of India surprised everybody on Thursday by cutting the Repo Rate by 25 basis points to 7.75 percent from 8 percent, ahead of its February 3 policy review.
The Repo is the rate at which RBI lends short term funds to banks.
"Households' inflation expectations have adapted, and both near-term and longer-term inflation expectations have eased to single digits for the first time since September 2009," the RBI said in a release on its decision to cut the benchmark rate.
Bankers and economists said the move would send out a positive signal that the RBI was now focused on growth, and that inflation was finally under control.
The Finance Ministry said it expected banks to pass on the rate cut to consumers through a 50 basis point-reduction in lending rates.
The RBI, in its statement, said inflation outcomes have fallen significantly below the eight per cent targeted by January 2015.
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"On current policy settings, inflation is likely to be below 6 per cent by January 2016. The path of inflation, while below the expected trajectory, has been consistent with the assessment of the balance of risks in the Reserve Bank's bi-monthly monetary policy statements," the release said.
Commenting on policy announcement made by the RBI today, Chandrajit Banerjee, Director General of the Confederation of Indian Industry (CII), said that the repo rate cut has come as a positive surprise in the new year and would be a huge mood lifter for investors who have been grappling with subdued demand conditions.
He said that CII feels that the 25 bps rate cut, even though symbolic, would send a strong signal down the line that both the government and the RBI are acting in concert to harness demand and take the economy to a higher orbit of growth. A rate cut would propel investment demand, spur spending in rate sensitive consumer durables and given a fillip to construction activity.
"Going forward, CII hopes that while maintaining a delicate balance between growth and inflation, the RBI would shift its stance in favour of growth, given that the trend in inflation is clearly subdued. CII would call for a further cut in policy rates by at least 25 basis points in the forthcoming monetary policy," added Mr Banerjee.
Rohit Raj Modi, President, CREDAI NCR and Mr. Aman Agarwal, Director, KV Developers also welcomed the move.
Rohit Raj Modi said,"CREDAI welcomes this move by the RBI. This will definitely pave the way for much required liquidity in the market. We have been raising the concerns of developers over higher rates from the government. We are happy that RBI has taken a step by cutting the rates. We expect that this will encourage banks to ease their home loan rates as the entire corporate sector will now shift its focus towards the Union Budget. This will help developers to expedite their projects which were otherwise facing fund crunch. Home buyers' dreams of owning a home would also get a boost as we expect an accelerated purchase cycle. This move by the RBI will act as a catalyst for the various reforms announced for the realty sector by the Government in the past. With this, we also see momentum going further in giving the real estate sector a much required push. While it is a welcome step, industry expects deeper cut in the upcoming review keeping in view that inflation has come down."
Agarwal said, "It is indeed a welcome move by RBI and will certainly help to lift the market sentiment. A large drop in international crude and other commodity prices have make inflation almost non-existent. Consequently, it was an anticipated step by RBI to boost the liquidity. A rate cut at this juncture will no doubt add to the existing positive growth impulses and would provide some easy growth excel for the economy. The reduction in rates will accelerate the downward movement of deposit rates and will also translate into lower rates for borrowers. However, it is advisable to make more cut in rates as the lower interest rates will drive the customers to be more focussed towards investments in properties."
He further said, "This will certainly send positive signals to the market and will become ray of hope for cash craved real estate sector and would encourage buyers to finalize their deals. We are hoping that in the coming months government will bring more optimism in the form of regulatory policy reforms similar to infra status, single window system."
Demands for a rate cut had been mounting following the steady decline in inflation. However, market was divided on whether the RBI would cut rate at its monetary policy review in February.
That is because Governor Raghuram Rajan had indicated that he would watch for signs of a sustainable decline in inflation before deciding on a rate cut.
"Crude prices, barring geo-political shocks, are expected to remain low over the year. Weak demand conditions have also moderated inflation excluding food and fuel, especially in the reading for December. Finally, the government has reiterated its commitment to adhering to its fiscal deficit target," the RBI release said.