Indian shares have fallen by 1.48% following the announcement
India's central bank cut its main interest rate for the second time this year on Tuesday, lowering it by 25 basis points in an effort to jumpstart a sharply slowing economy.
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 but said there was limited "headroom" for further rate reductions.
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 after the announcement, the third day of losses in a row, as a regional party pulled out of the ruling coalition in New Delhi, raising political uncertainty and concerns about future economic reforms.
The Sensex closed down 1.48 percent at 19,008.1 points.
Indranil Pan, chief economist at Kotak Mahindra Bank, said the cut was in line with expectations but the bank's statement was "relatively more hawkish than one would have expected in the midst of a rate cutting cycle.”
"This clearly re-establishes the concerns in the minds of the RBI on the stability of the economy," he said in a note.
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.
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 government's efforts to rein in over-spending.
The rate cut was welcomed by businesses and industry leaders, although some had hoped for a bigger cut.
"The decision...in response to the fiscal consolidation efforts made by the government, has sent a strong signal that the RBI and the government would work in tandem to bring growth back to the economy," said Adi Godrej, President of the Confederation of Indian Industry.
The RBI had slashed rates by 25 basis points at its previous meeting in January -- its first such move since last April.
At Tuesday's meeting, the RBI left the cash reserve ratio unchanged. The bank has steadily cut this rate in previous meetings, reducing the value of deposits banks must keep with the central bank.
Subbarao said last week that 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, seeking to rebut charges that the bank is stifling growth.
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.