India's central bank moved to pump billions of dollars into the banking system on Tuesday amid concerns about slowing growth in Asia's third-biggest economy but said it was too soon to cut interest rates.
The Reserve Bank of India (RBI) cut the cash reserve ratio for commercial banks by 50 basis points -- reducing the percentage of cash they need to hold in reserve and in effect allowing them to lend more.
RBI governor Duvvuri Subbarao said the bank had shifted its focus towards promoting growth, while ensuring that inflationary pressures "remain contained."
After the policy meeting in India's financial capital Mumbai, the bank's repo rate, at which it lends to commercial banks, remained at a near four-year high of 8.50 percent, in line with market expectations.
The reverse repo rate that it pays banks for deposits was unchanged at 7.50 percent -- its highest in more than a decade.
The RBI slashed its prediction for growth to 7.0 percent from a previous 7.6 percent, saying the economy was "decelerating" due to global financial uncertainty and the impact of the previous rate hikes.
The RBI has raised interest rates 13 times since March 2010 in a prolonged battle against inflation, which hovered close to 10 percent for most of last year.
India's inflation is now at a two-year-low of 7.47 percent on an annual basis, mainly due to falling prices of food and vegetables, but it is still above the bank's comfort level of around five percent.
While other developing nations from Brazil to Indonesia have cut rates to shield their economies from the global downturn, India has kept up its anti-inflationary stance.
"Based on the current inflation trajectory, it is premature to begin reducing the policy (interest) rate," RBI governor Subbarao said.
"The upside risks to inflation arise from global crude oil prices and the lingering impact of rupee depreciation," Subbarao said.
But the stock market Sensex index jumped 1.39 percent to 16,985.3 points in expectation that the central bank would cut rates in coming months.
"The (RBI action) was expected," said Shubhada Rao, chief economist at private Yes Bank.
The cash reserve ratio, which was last reduced more than three years ago, now stands at 5.5 percent and is expected to pump 320 billion rupees ($6.27 billion) into the banking system.
Rao expects the RBI to cut rates by 50 basis points when it next meets in March, but added that the government will have to do more on the policy front.
Strong growth is seen as essential to help improve the lives of India's 1.2 billion people, 75 percent of whom live on less than $2 a day, according to World Bank figures.
Although India's projected growth remains enviable by Western standards, it is too slow to fulfill government pledges of significant poverty reduction and to create enough jobs for a soaring young workforce.
The economy grew 8.5 percent last year.