By Suvashree Dey Choudhury and Tony Munroe
MUMBAI (Reuters) - The Reserve Bank of India cut the repo rate by 25 basis points on Friday for the third time since January, as expected, as growth slows and inflation ebbs, but said there is little room to ease monetary policy further, disappointing markets.
The Reserve Bank of India trimmed the repo rate to 7.25 percent, its lowest since May 2011, and kept the cash reserve ratio (CRR) for banks unchanged at 4 percent, also in line with expectations.
However, it warned that the risk of inflationary pressure persists despite a recent sharp decline in wholesale price index (WPI) inflation, and said a high current account deficit poses the biggest risk "by far" to the Indian economy.
"The balance of risks stemming from the Reserve Bank's assessment of the growth-inflation dynamic yields little space for further monetary easing," the RBI wrote in its policy statement.
Some in the market had been hoping for more aggressive policy easing action and a less hawkish tone from RBI Governor Duvvuri Subbarao as India grapples with economic growth that slowed to about 5 percent in the fiscal year that ended in March, its weakest in a decade.
Indian stocks and the rupee fell and bond yields rose after the policy statement.
"In essence, the guidance from the central bank is that the correction in the inflation and current account position is more cyclical rather than structural," said Radhika Rao, economist at DBS in Singapore.
"Some sacrifice by way of slower growth seems inevitable then," she said.
India's headline inflation in March fell to its lowest in more than three years at 5.96 percent, but the consumer price index remained elevated at 10.39 percent.
Graphic: Inflation, repo rates, output, click http://link.reuters.com/deq95s
For fiscal deficit, click http://link.reuters.com/qux84t
Web page, click http://in.reuters.com/subjects/rbi-policy-review
The current account deficit swelled to a record 6.7 percent of GDP in the December quarter. While it is expected to ease on lower global commodity prices and a rise in exports, it is on track to remain well above the 2.5 percent level that is seen as sustainable.
"Should global liquidity conditions rapidly tighten, India could potentially face a problem of sudden stop and reversal of capital flows jeopardising our macro-financial stability," it said.
The central bank said it expects the economy to grow at 5.7 percent in the fiscal year that started in April, and projected headline WPI inflation at around 5.5 percent during the year.
It said its intention is to lower WPI inflation to 5 percent by March 2014 "using all instruments at its command."
"When they say there is little room to cut, it suggests there is one more cut, maybe not in the next policy review but possibly in July provided inflation continues to come down," said A. Prasanna, economist at ICICI Securities Primary Dealership in Mumbai.
The RBI once again urged the government to take measures to ease supply constraints in the economy and encourage investment.
"Without policy efforts to unlock the tightening supply constraints and bring enduring improvements in productivity and competitiveness, growth could weaken even further and inflationary strains could re-emerge," it said.
Long a hawkish global outlier as it struggled to keep inflation in check, the RBI began cutting interest rates in April 2012 but that easing has done little to spur demand in Asia's third-largest economy as bureaucratic red tape and regulatory uncertainty have deterred capital investment.
Finance Minister P. Chidambaram, who has been pushing for pro-growth reforms and has been courting global investors, has also called for further monetary easing to boost growth.
(Editing by Simon Cameron-Moore)
