India cuts key interest rate to spur economy

India's central bank cut its main interest rate by 25 basis points on Tuesday -- its second such reduction this year -- in an effort to jumpstart a sharply slowing economy.

But central bankers warned that still stubbornly entrenched inflation limited the "headroom" for further rate cuts.

The Reserve Bank of India (RBI) announced it would lower the benchmark repo rate, at which it lends to commercial banks, by a quarter percentage point to 7.50 percent in a move widely expected by economists.

Business leaders have been calling for lower borrowing costs to help the economy, which is projected to grow at just five percent in the current financial year to March 31, the lowest pace in a decade.

The bank warned that with headline inflation lower, but not yet tamed, substantial future rates cuts could not be guaranteed.

"Even as the policy stance emphasises addressing the growth risks, the headroom for further monetary easing remains quite limited," RBI governor Duvvuri Subbarao said in a statement on the bank's website after the meeting.

Indian shares fell 0.66 percent after the announcement on worries about chances for further rate cuts.

The cash reserve ratio -- the percentage of deposits banks must keep with the central bank -- was kept unchanged.

While overall annual inflation rose in January, core inflation -- which strips out volatile goods such as food and fuel and is closely watched by the RBI -- fell to a near three-year-low of 3.8 percent.

"We have seen a sharp drop in core inflation. The fiscal situation looks under control," said Siddhartha Sanyal, chief India economist at Barclays Capital.

"In this scenario, a rate cut had been widely expected," he told AFP.

India's finance minister P. Chidambaram in his budget last month pledged to cut a gaping fiscal deficit in a bid to avert a damaging credit ratings downgrade and help revive sustained growth.

Chidambaram said ahead of the RBI's decision that the bank should "take comfort" from the government's fiscal reduction efforts.

The RBI had slashed rates by 25 basis points at its previous meeting in January -- its first such move since last April.

But Subbarao last week said he was still worried about inflation, which he said hurt growth prospects when above 6.0 percent.

"It's not possible to bring inflation down without sacrificing some growth. But you have to realise the growth sacrifice is only in the short term," he said.

"In the medium term, low inflation -- price stability -- is very important for sustained growth," he said, seeking to rebut charges that the bank is stifling growth by not lowering borrowing costs quickly enough.

The Congress-led government, led by Prime Minister Manmohan Singh, has been battered by a spate of corruption scandals and is keen to revive economic growth before facing voters in elections due in 2014.