RBI unexpectedly cuts key rate in pre-election boost for PM Modi

By Suvashree Choudhury and Swati Bhat

MUMBAI (Reuters) - The Reserve Bank of India (RBI) on Thursday unexpectedly lowered interest rates and, as anticipated, changed its policy stance to "neutral" to boost a slowing economy after a sharp slide in the inflation rate.

The cut is welcome news for Prime Minister Narendra Modi's government, which wants to boost lending and lift growth as it faces elections by May.

The ruling Bharatiya Janata Party is already in election mode. In its budget on Feb. 1, the government doled out cash to farmers and tax cuts to middle-class families, at the cost of a wider fiscal deficit and larger borrowing.

India's new RBI governor Shaktikanta Das "has delivered what the Modi government was hoping for," said Mark Williams, chief Asia economist of Capital Economics, in a note.

The RBI's monetary policy committee (MPC) cut the repo rate by 25 basis points to 6.25 percent, as forecast by 21 of 65 analysts polled by Reuters. Most respondents had expected the central bank to only change the stance, to neutral from "calibrated tightening".

If inflation remains muted, Das hinted there is more room to cut rates, sounding a markedly more dovish tone from the central bank.

"In the 12-month horizon, if we see that inflation remains at 3.9 or maximum of 4 percent or below, then I think there is a room to act," Das told reporters after Thursday's decision.

The rate cut continues a trend in which some major central banks, worried about slowing global growth and helped by cooling inflation, have moved firmly away from last year's tightening moves or tones. The Federal Reserve has changed direction, and now many analysts expect no U.S. rate hikes this year, after four in 2018.

India's last repo rate cut, to 6.00 percent, came in August 2017.

SLOWER GROWTH

Das also downplayed the risk of inflation rising due to the forecast of fiscal slippage in last week's budget, and said the MPC will only look at the headline inflation number and ignore core inflation that has proven sticky.

India's core inflation was pegged at around 5.7 percent in December. Consumer inflation was an 18-month low of 2.19 percent, well below the RBI's medium-term 4 percent target. The pace has steadily dropped since June's 4.92 percent.

For April-September, the MPC lowered its projection on headline inflation to 3.2-3.4 percent from the 3.8-4.2 percent seen in December.

The MPC also trimmed its economic growth forecast, to 7.2-7.4 percent during April-September, from its previous 7.5 percent estimate.

"The central bank's commentary on inflation and growth support a dovish outlook for the policy," said Shashank Mendiratta, an economist with IBM in New Delhi, adding "The macro backdrop as such supports the RBI's stance."

Economic growth fell to a worse-than-expected 7.1 percent in the July-September quarter from 8.2 percent in the previous one, due to slower consumer spending and farm growth.

GOVERNMENT PRESSURE

Four of the six MPC members voted to cut the rates, while all backed the change in stance.

In a tweet, Economic Affairs Secretary Subhash Chandra Garg welcomed the rate cut and stance change, saying the MPC had come up with a "balanced and pragmatic policy statement".

The MPC meeting - the first for Das as governor - was closely watched after tension between the RBI and the government prompted his predecessor Urjit Patel to abruptly quit in December, amid government demands to relax lending curbs and hand over surplus reserves.

Patel's exit prompted some to fret the RBI's independence was under threat, but some economists argued that Thursday's decision should not be read as a surrender to pressure.

"To see this as a capitulation of the government's demands is profoundly misguided," said Abheek Barua, chief economist of HDFC Bank. "Both recent history and forward guidance make a compelling case for the rate cut. Going by the guidance, there is room for a further rate cut."

The rupee weakened to 71.69 to the dollar immediately after the decision, but it later strengthened to 71.42.

The NSE Nifty initially slipped but closee up 0.06 percent at 11,069.40 while the 10-year benchmark government bond yield fell to 7.51 percent from Wednesday's close of 7.56 percent.

(Reporting by Suvashree Dey Choudhury and Swati Bhat; Additional reporting by Mumbai and Bengaluru Newsrooms; Editing by Euan Rocha and Richard Borsuk)