India's central bank lowered its policy repo rate by 25 basis points to 7.5 per cent on Wednesday, its second inter-meeting cut this year on the back of easing inflation and what it said was the "weak state" of parts of the economy.

Although markets had broadly expected the Reserve Bank of India to cut rates again after its surprise January easing, few had expected a move as early as this week, just days after the government presented its annual budget for the coming fiscal year.

"Given low capacity utilisation and still-weak indicators of production and credit off-take, it is appropriate for the Reserve Bank to be pre-emptive in its policy action to utilise available space for monetary accommodation," RBI Governor Raghuram Rajan said in a statement.

The cut comes days after the government and the Reserve Bank of India agreed to formally adopt inflation targeting, although the central bank had been effectively using targets since early 2014.

Analysts said the RBI's rate cut appeared to give backing to the government's fiscal plans and its pledge to exercise responsibility despite a delay in meeting a fiscal deficit target of 3 per cent of gross domestic product by a year to 2017/18.

"The Reserve Bank of India is expressing its confidence on inflation outlook," said Radhika Rao, economist at DBS in Singapore. "This also means that despite a higher fiscal deficit, the quality of fiscal consolidation has satisfied central bank's expectations."

Indeed, in an otherwise cautious policy statement, central bank governor Raghuram Rajan said fiscal and monetary policy would work "in a complementary way": "The fiscal consolidation programme, while delayed, may compensate in quality, especially if state governments are cooperative," Rajan said.

Indian bonds and rupee rose sharply after the cut. The benchmark 10-year bond yield dropped to as much as 7.61 per cent, its lowest level since July 15, 2013. The partially convertible rupee gained to as much as 61.65 to the dollar, its strongest level since Feb. 4.

MORE TO COME?

While Rajan signalled positive trends in inflation, analysts cautioned that the prospect of slashing rates was reduced, given the new inflation targets and a statement that contained words of warning as well as encouragement.

"I feel another 25 bps is possible, maybe in the April policy but after that there will be a pause," said Rupa Rege Nitsure, group chief economist at L&T Financial Services.

Indian inflation has moderated sharply as oil prices slumped since last year. In January, consumer prices rose an annual 5.11 per cent, having fallen from double digit levels as recently as November 2013.

That was well within the inflation target of 4 per cent, with a band of plus or minus 2 per centage points, agreed by the RBI and the government, which will be set starting from the financial year ending in March 2017.

Rajan said in the statement the RBI would seek to bring the inflation rate to 4 per cent, the midpoint of that band by the end of the two-year period starting in 2016/17.

The statement also noted that the rupee's relative strength added to disinflationary pressures, although Rajan said the RBI does not target exchange rates or have a target for currency reserves.

Rajan also cast doubt on the government's revision to its data methodology last month that resulted in the economy showing growth of 7.5 per cent year-on-year during the last quarter, higher than China, when previously India's economy was regarded as struggling to get out of a rut.

"The picture it presents of a robust economy, with growth having picked up significantly over the last three years, is at odds with still-low direct measures of growth of production, credit, imports and capacity utilisation as well as with anecdotal evidence on the state of the economic cycle," Rajan said.

"Nevertheless, the picture of a steadily recovering economy appears right."

The RBI had first lowered interest rates this year on Jan. 15, in a similarly unexpected move. Both rate cuts took place outside of the central bank's scheduled policy review meetings. – Reuters