The Reserve Bank of India (RBI) cut its key repo rate for the first time in nearly five years on Friday and signalled a less restrictive policy approach ahead, as it seeks to provide stimulus to the sluggish economy.

The Monetary Policy Committee (MPC), which consists of three RBI and three external members, cut the repo rate by 25 basis points to 6.25% after having kept it unchanged for eleven straight policy meetings.

The decision was in line with a Reuters poll, where over 70% of economists had predicted a quarter-point reduction, and marked the first reduction in India’s key rate since May 2020.

All six MPC members voted to cut rate and to maintain the monetary policy stance at “neutral”.

The MPC noted that though growth is expected to recover, it is much lower than last year and inflation dynamics have opened space for rate easing, RBI Governor Sanjay Malhotra said in the first policy review since his appointment in December.

“The MPC while continuing with the neutral stance felt that a less restrictive monetary policy is appropriate at this current juncture,” Malhotra said.

India’s benchmark 10-year bond yield was up five basis points at 6.70% after the announcement, while the rupee and benchmark equity indexes weakened marginally.

“The MPC refrained from an outright dovish signal by maintaining a ‘neutral’ stance, said Radhika Rao, senior economist at DBS Bank in Singapore.

Most economists polled by Reuters ahead of the policy meeting had forecast Friday’s cut and only one more reduction of 25 bps in April, taking the policy rate down to 6%.

India’s government has forecast annual growth of 6.4% in the year ending in March, below the lower end of its initial projection, weighed by a weaker manufacturing sector and slower corporate investments. That would be its slowest pace of expansion in four years.

Growth is seen in a 6.3%-6.8% range in the next fiscal year as well.

The central bank on Friday forecast growth of 6.7% next year.

Improving employment conditions, recently announced tax cuts, moderating inflation and good agricultural output after a strong monsoon will help growth, Malhotra said.

Though retail inflation is still well above the RBI’s medium-term target of 4%, it eased to a four-month low of 5.22% in December and is seen gradually declining towards the target in coming months.

The central bank sees inflation averaging 4.8% in the current financial year, easing to 4.2% next year.

Food inflation pressures are expected to ease, Malhotra said, but added that volatile energy prices pose a risk to the inflation outlook.

Core inflation, though likely to rise, will remain moderate, Malhotra said.

BALANCING TRADE-OFFS

Malhotra, who was earlier a top official in the federal ministry of finance, used his first policy announcement to lay down the central bank’s priorities, suggesting a shift from the tight banking regulations pursued under predecessor Shaktikanta Das.

“There are trade-offs between stability and efficiency,” Malhotra said, referring to draft rules which propose to raise capital requirements for bank lending to under-construction infrastructure projects and raise the liquidity requirement against digital deposits.

“We will keep this trade-off in mind while formulating regulations. It will be our attempt to strike the right balance, keeping in view the benefits and costs of each and every regulation,” he said.

The Indian government in rare public comments had said tight banking regulations were responsible for part of the slowdown and officials had privately advised against the new rules, Reuters reported last year.

Since Malhotra has taken over, the rupee has weakened and volatility has risen, prompting markets to speculate that the central bank was easing its grip on the currency.

Under Das, rupee volatility had fallen to multi-decade lows as the central bank intervened heavily to keep the rupee in a narrow band.

Malhotra stuck to the long-held position of the central bank that interventions are only intended to smoothen “excessive and disruptive volatility rather than targeting any specific exchange rate level or bank”.

“The exchange rate of the Indian rupee is determined by market forces,” he said.

The rupee fell marginally after the policy, trading at 87.47, close to the record low of 87.58.