The Reserve Bank of India today cut cut key policy rates to infuse more money into the banking system and also trigger lower interest rates on loans taken by the commercial and household sectors.

The repurchase rate, the interest charged by the Reserve Bank of India (RBI) on short-term borrowings by commercial banks, has been cut by 25 basis points to 7.75 percent. This has the potential to lower the cost of borrowings for banks.

Also, the cash reserve ratio, or the money against deposits which commercial banks have to retain in liquid assets, has also been lowered from 4.25 per cent to 4 percent.

"This reduction in the cash reserve ratio will inject primary liquidity of around Rs.180 billion into the banking system," RBI Governor D. Subbarao said in his third quarter review of the monetary policy for the current fiscal.

In its review document, the central bank said that the decision to ease the monetary policy stance is based on softened inflation, GDP deceleration and tight liquidity conditions.

"First, both headline wholesale price inflation and its core component, non-food manufactured products inflation, have softened through the third quarter. This provided some relief from the persistence that dominated the first half of the year," said the apex bank.

"Second, growth has decelerated significantly below trend through the last fiscal year and through this year so far, and overall economic activity remains subdued. . . While the series of policy measures announced by the Government has boosted market sentiment, the investment outlook is still lacklustre, especially in terms of demand for new projects," it added.

On liquidity conditions, RBI said, "The average net LAF borrowings at `910 billion in January have been above the Reserve Bank’s comfort level. This tightness could potentially hurt credit flow to productive sectors of the economy. The structural deficit in the system provided a strong case for injecting permanent primary liquidity into the system."

RBI said that the move is expected to encourage investment to help growth, improve liquidity conditions to support credit flow, and anchor medium-term inflation expectations on the basis of a credible commitment to low and stable inflation.