Two weeks after bankers meet and few days after encouraging IIP (index of industrial production) at 3.8% in November, the Reserve Bank of India suprised many on Thursday by making an unscheduled announcement on cut in repo rate by 25 basis point.

Recalling its assurance made during fifth bi-monthly monetary policy statement of December which stated that “if the current inflation momentum and changes in inflation expectations continue, and fiscal developments are encouraging, a change in the monetary policy stance is likely early next year”, RBI on Thursday finally made changes in the repo rate by slashing it by  25 basis points to 7.75 per cent from 8 percent.

Commerce Minister - RBI's #Ratecut signals the beginning of a low interest regime & is highly encouraging for the Industry & economy #PIB

— CIM India@GOI (@CimGOI) January 15, 2015

However, the RBI decided keep cash reserve ratio (CRR) of scheduled banks unchanged at four per cent of net demand and time liabilities (NDTL). A change in monetary policy was not expeted as the central bank has a scheduled policy review meeting on February 3.

With visible signs of inflation slowing down in last few months and government coping to control fiscal deficit, the move was much desired. Post announcement RBI governor Raghuram Rajan in a statement said “Since July 2014, inflationary pressures (measured by changes in the consumer price index) have been easing. 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.”

 “To some extent, lower than expected inflation has been enabled by the sharper than expected decline in prices of vegetables and fruits since September, ebbing price pressures in respect of cereals and the large fall in international commodity prices, particularly crude oil. 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 statement said.

Welcome RBI's decision of #Ratecut.Highly encouraging for the Economy.Steps taken by us to control inflation have started yielding results.

— CIM India@GOI (@CimGOI) January 15, 2015

“These factors have significantly reduced the momentum of inflation, compensating for the widely anticipated ending of favourable base effects. 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. Inflation outcomes have fallen significantly below the 8 per cent targeted by January 2015. On current policy settings, inflation is likely to be below 6 per cent by January 2016,” the RBI said.

What is Repo Rate?
Repo rate or repurchase rate is the rate at which banks borrow money from the central bank (RBI for India) for a short period by selling their securities (financial assets) to the central bank with an agreement to repurchase it at a future date at predetermined price. It is similar to borrowing money from a money-lender by selling him something, and later buying it back at a pre-fixed price. The reduction in the repo rate makes the borrowing for the banks cheaper and banks have more money which they can use for lending.

Mood lifter, says CII

Commenting on policy announcement  Chandrajit Banerjee, Director General, CII said that the 25 bps reduction in repo rate 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.

“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 Banerjee.