RBI Governor Raghuram Rajan delivered the first policy rate cut of the current financial year on Tuesday, paring the interest rate at which banks borrow from the central bank (repo rate) to 7.25 per cent from 7.50 per cent.

Banks heeded the RBI’s call to pass on the rate cut with a few public sector banks cutting lending rates by up to 30 basis points. Loans to housing, auto, small and medium enterprises and large corporates are expected to get a tad cheaper.

The widely anticipated policy rate cut, however, brought no cheer to the equity market. The benchmark BSE Sensex fell 661 points due to a slightly upward revision in the retail inflation projection, and the Governor’s comments about the rate cut being frontloaded. Banking and auto sector stocks took a beating.

In its second bi-monthly policy statement, the RBI revised the inflation projection upwards to 6 per cent by January 2016 from 5.8 per cent in April 2015.

The RBI had kept the repo rate unchanged at 7.5 per cent in its first bi-monthly policy statement in April. Before Tuesday’s cut, the repo rate had been lowered twice this calendar year, by 25 basis points each, in mid-January and early March. Both reductions took place outside the review cycle.

On Tuesday, the RBI reasoned there is a case for a rate cut in the backdrop of low domestic capacity utilisation, mixed indicators of a recovery, and subdued investment and credit growth.

CEA reaction In Delhi, Chief Economic Adviser Arvind Subramanian said the RBI’s move was consistent with the trends in the economy, including declining inflation and strong fiscal discipline.

“The government and the RBI agree that these cuts signify that the economy needs policy support as economic growth is recovering while the external environment remains weak,” he said.

The CEA added that the government and RBI will work together to ensure the macroeconomic situation remains strong while investment and growth are accelerated. He was hopeful of containing inflation despite the forecast of a poor monsoon.

The RBI has marked down the GDP growth projection for 2015-16 to 7.6 per cent from 7.8 per cent to reflect the uncertainty hovering over economic activity. It listed three risks that still cloud the inflation picture: a below normal monsoon, firming crude prices and volatility in the external environment. Pointing out that successive estimates have indicated a worsening of the agriculture situation, Rajan said the Government needed to have contingency plans for food management.

Banks lower rates Taking the RBI Governor’s cue, India’s largest bank, State Bank of India, pared its base rate (minimum lending rate) to 9.70 per cent from 9.85 per cent. The new base rate is effective from June 8. Allahabad Bank cut its base rate to 9.95 per cent (from 10.25 per cent), and Dena Bank to 10 per cent (10.25 per cent).

Read : Second bi-monthly RBI Monetary Policy Statement 2015-16

Biggest uncertainty

The central bank chief said the biggest uncertainty ahead was the outcome of the annual monsoon, after the rains missed their normal start date, along with subsequent government action.

"Each path of the sequence is fraught with uncertainty. So we need to figure out how this plays out. And, clearly government action is very important," Reserve Bank of India Governor Raghuram Rajan said after the central bank's policy meeting on Tuesday.

He added that the decision has been taken in line with the economic data.