India's central bank reduced its key rates for the first time in nine months, reinforcing its shift in stance to address growth risks. However, the bank sees limited scope for aggressive reductions, given the higher inflation level.

The Reserve Bank of India, or RBI, decided to cut the repo rate to 7.75 percent from 8 percent as widely expected by economists at its third quarter review on Tuesday. The reverse repo rate was adjusted to 6.75 percent from 7 percent.

The new rates came into effect immediately. The repo rate is the rate at which the central bank lends to banks and the reverse repo rate is the rate at which it accepts deposits from banks.

The central bank also unexpectedly lowered its cash reserve ratio by a quarter point to 4.00 percent, effective February 9. The bank was expected to retain the CRR at 4.25 percent.

The reduction is set to inject INR 180 billion liquidity into the banking system. The bank last reduced CRR in October 2012.

The central bank expects the latest actions to support growth by encouraging investment and anchor medium term inflation expectations.

Even as the monetary policy stance shifts further towards mitigating growth risks, the bank said the objective of containing inflation and anchoring inflation expectations is not de-emphasised.

The RBI action came after wholesale price inflation moderated to 7.18 percent in December from 7.24 percent in November. The bank revised down its baseline wholesale price inflation projection for March 2013 to 6.8 percent from 7.5 percent.

Although the monetary policy stance has sought to balance the growth-inflation dynamic through calibrated easing, it is critical now to arrest the loss of growth momentum without endangering external stability, the central bank observed.

"With headline inflation likely to have peaked and non-food manufactured products inflation declining steadily over the last few months, there is an increasing likelihood of inflation remaining range-bound around current levels going into 2013-14," said Governor Duvvuri Subbarao.

"This provides space, albeit limited, for monetary policy to give greater emphasis to growth risks." However, Subbarao said the above guidance will be conditioned by the evolving growth-inflation dynamic and the management of risks from twin deficits.

Chakravarthi Rangarajan, the Chairman of the Prime Minister's Economic Advisory Council said the central bank has taken a balanced view and the rate cut will stimulate economic growth.

The economic growth estimate for 2012-13 was also downgraded to 5.5 percent from 5.8 percent. For the current fiscal year, the government estimates 5.7 to 5.9 percent growth.

India recently announced a string of reforms to shrink its massive current account deficit and to restart recovery. The government hiked the import duty on gold and crude edible oil and gave a free hand to the oil companies to adjust the highly-subsidized diesel tariffs.

Last week, Finance Minister Palaniappan Chidambaram said the government will cut its budget deficit to 4.8 percent in 2013-14, from an estimated 5.3 percent in the current year.

The RBI today said large fiscal deficits will lift the current account deficit risk, and will further crowd out private investment and stunt growth impulses.

RTTNews