MUMBAI, Aug 23: India’s central bank cut the key short-term interest rate benchmark by half a point on Saturday, a move expected to aid recovery in Asia’s third-largest economy, analysts said.

A central bank spokeswoman said the cut to 4.5 per cent, to take effect on August 25, had been decided in the light of low inflation and a good monsoon.

The announcement came shortly after news that India’s foreign exchange reserves have risen above the $85 billion-mark for the first time. Analysts said it will reduce the gap over US rates and moderate arbitrage-seeking foreign exchange inflows.

The repo rate is what the central bank pays to borrow short-term funds against securities. It was last cut on March 3.

Conditions are in now place for an industrial investment boom to take place by the financial year-end, said Sanjeev Sanyal, Singapore-based economist at Deutsche Bank.

Inflation, as measured by wholesale prices, fell to 3.96 per cent in the year to August 2 from 5.32 per cent in late June, helped by a fall in prices of agricultural goods and analysts expect good rains to keep prices of farm goods from rising.

The southwest monsoon is the lifeline of the Indian economy as over two-thirds of the nation’s billion-plus population lives off the land and only one-third of the arable land is irrigated. The farm sector accounts for a quarter of India’s GDP.

Last year the country was hit by the worst drought in 15 years with rains dipping to 70 per cent of the average in June and July, causing farm sector output to shrink and GDP growth to slump to 4.3 per cent from 5.6 per cent in the previous year.

The repo rate cut, which is expected to bring down most other Indian interest rates from bond yields to bank deposit rates, will help reduce some of the foreign exchange investment inflows which sought higher returns in the Indian market.

There will be a re-alignment of local interest rates with global rates, which could moderate forex inflows by way of individual remittances and even overseas Indians’ deposits, said Dhananjay Sinha, economist at ICICI Bank.

India’s foreign exchange reserves have risen by $15 billion so far this year.

The RBI’s moves to mop up the surging forex inflows have flooded the domestic banking system with liquidity, forcing banks to buy bonds with credit demand still sluggish. Investment in equities by banks is restricted.

The central bank has been trying to combat the monetary impact of the rapid accumulation of reserves and the recent fall in inflation has given it room to manouevre by allowing it to cut interest rates, Deutsche Bank’s Sanyal said.

But some felt the effect may be muted. U. Venkataraman, trading head at IDBI Bank, said that overall foreign exchange inflows may not be much impacted because of the country’s better growth prospects.

The stock market has revived and with this cut, more money is likely to flow into the capital market, he said.

The unexpected large cut and early timing sent bond yield quotes sliding to historic lows, with the benchmark 10-year yield down 17 basis points to 5.40 per cent, the biggest single-day tumble in this financial year.

And there is scope for yields to fall another 10 basis points over the next couple of days, as many traders missed out on today’s rally because of the late announcement of the cut, said M.S. Gopikrishnan, senior vice president at primary dealer IDBI Capital Market Services.

The central bank announced the cut just before close of trade and traders said there were no deals in the benchmark bond following the announcement.

But the curve will steepen in the weeks ahead as short-term yields fall more sharply than long term yields in a recovering economy, Gopikrishnan said. —Reuters