India’s central bank surprised markets with an early-morning lending-rate cut on Thursday, stepping back from its inflation-fighting stance in hopes of helping bolster growth in Asia’s third-largest economy.
The Reserve Bank of India’s decision to lower the interest rate it charges banks by 0.25 percentage point to 7.75% was the first rate reduction in nearly two years. Central bank Gov. Raghuram Rajan said he decided to lower rates because of signs that India has been winning its long battle with inflation in recent months as oil and food prices have slid.
“These developments have provided headroom for a shift in the monetary policy stance,” Mr. Rajan said in the statement announcing his first rate cut since becoming governor. “In its public interactions, the RBI had committed to initiate the process of monetary easing as soon as data indicated that medium-term inflationary targets would be met.”
India’s main stock index jumped more than 2% and the rupee strengthened against the dollar on the announcement.
“With inflation expectations sharply down, there was no further reason to keep rates as high as they were,” said Rahul Bajoria, a regional economist with Barclays in Hong Kong.
Economists said they expect more rate cuts to follow and the resulting lower borrowing costs to lead to more consumer and corporate spending.
“With this cut and the ones to come in the next months, the RBI’s monetary policy stance is proving to be supportive of growth,” said Rohini Malkani, an analyst at Citigroup India.
Ms. Malkani predicts that the RBI will cut rates by a total one percentage point over the next 15 months, helping boost gross domestic product expansion to 6.5% in the fiscal year ending March 2016, up from around 5.6% this year.
Mr. Rajan, who became governor of the central bank in September 2013, started his time at the RBI’s helm by building a reputation as an inflation fighter with consecutive rate increases.
He switched the central bank’s focus to the consumer-price inflation rate, which had climbed to near 10%, and set a clear goal of getting that rate to 8% by the end of last year and to 6% by next year.
India’s economic slowdown as well as falling oil prices have helped bring India’s consumer price index inflation rate down below 6% in recent months. The global slide in commodity prices has also helped cap food inflation.
“It’s been a three-step process,” which has given the RBI confidence it is time to cut rates, said Taimur Baig, chief economist Asia at Deutsche Bank. “First the slowdown in food prices, then the positive effects of the fall in commodity prices, and finally the decline in inflation expectations.”
Global financial markets have also turned more benign recently. Mr. Rajan has expressed concerns in the past that an end of the easy-money policies of the U.S. could trigger a sell off of emerging market assets, like the one that happened in 2013. However the rupee as well as Indian stocks and bonds have been relatively strong in recent months.
Analysts said Mr. Rajan acted on Thursday morning, weeks ahead of the regular monetary policy meeting, because he had no reason to wait any longer.
He may have chosen to surprise markets as surprises sometimes have a bigger impact on sentiment that widely anticipated moves, said Madan Sabnavis, chief economist at CARE rating agency.
“Monetary policy works better when there is a surprise,” said Mr. Sabnavis, who expects RBI to cut rates another 0.75 percentage point this year.
India’s rate cut comes after China surprised the market in late November with its own reduction and two rate cuts late last year from the Bank of Korea.
As India has been struggling with high inflation, many governments in Asia have been battling low inflation, which increases real interest rates and weighs on growth.
China’s slowing economy has added to a dour economic outlook in much of Asia in recent months and feeble corporate-investment in many Asian nations has also slowed increases in prices. The risk is that low inflation will keep a cap on business outlays and wages and crimp consumer and corporate spending.
Cheaper global crude oil has offered the central banks of Asia a window to ease monetary policy and spur demand.
The Bank of Korea left its benchmark rate unchanged at 2% on Thursday. But many analysts expect it to cut again in February or March due to fears about low inflation and anemic growth.