India's central bank cuts rate, but warns of risks

India's central bank cut its main interest rate by 25 basis points on Friday in the third such move this year, but said there was "little space" for further reductions to help the slowing economy.

After meeting in the financial capital Mumbai, the Reserve Bank of India (RBI) said that the benchmark repo rate, at which it lends to commercial banks, would fall to 7.25 percent, as expected by most economists.

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

Explaining the rate cut, the RBI governor Duvvuri Subbarao said that "growth had decelerated continuously," forecasting expansion of 5.7 percent in the new fiscal year -- far below the government's estimate of 6.0-6.5 percent.

But he warned that there were "significant risks" to inflation in the near-term and said that "monetary policy cannot afford to lower its guard against the possibility of a resurgence of inflation pressures".

India's headline inflation has eased to a three-year-low of 5.96 percent in March, but consumer price index is elevated at 10.39 percent, led mainly by high food prices.

The governor also struck a cautious tone about future rate cuts, saying: "Overall, the balance of risks stemming from our assessment of the growth-inflation dynamics, yields little space for further monetary easing."

The RBI's decision to cut rates had been forecast by economists and business leaders, who have been calling for lower borrowing costs to help the economy, which grew at an estimated 5.0 percent in the full year to March.

Indian shares initially slid 0.67 percent to 19,604.17 points, reacting to the news that further rate cuts were unlikely in coming months, but then recovered to trade down 0.10 percent around midday.

"Friday's action was expected. The tone from the bank governor was cautious, which was also expected," said Siddhartha Sanyal, chief India economist with Barclays Capital.

Another economist Shubhadao Rao with private Yes Bank said the RBI's tone was "hawkish". She expects one more rate cut after Friday's action, as the macro-economic conditions in terms of growth and inflation will improve in coming months.

The World Bank on Tuesday lowered its forecast for growth to 6.1 percent for the new fiscal year which started in April, from the 7.0 percent projected six months ago.

Subbarao said that the biggest risk to India's economy came from the current account deficit, which widened to a record 6.7 percent of GDP in the December quarter.

The bank reiterated that the government should take measures to encourage investment, as policy action was not enough to stimulate the economy.

The 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 general elections due in 2014.

The RBI slashed rates by 25 basis points at its previous two meetings in March and January. Rates had previously been on hold for nine months.