India's central bank cut its key interest rate by a quarter percentage point to 7.75 percent Tuesday, aiming to boost flagging growth in Asia's third-largest economy.
The Reserve Bank of India also lowered its cash reserve ratio for banks by a quarter point to 4 percent, which means commercial banks can lend more.
India's economic growth has slowed for several quarters amid high inflation and delays to economic reforms that chilled investment.
The central bank cut its economic growth forecast for the fiscal year ending March 2013 to 5.5 percent from 5.8 percent.
It said the lower cash reserve ratio would release an extra 180 billion rupees ($3.3 billion) into the banking system.
The RBI has held off cutting rates at previous monetary policy meetings because of high inflation. Its last rate cut was in April 2012.
In its latest monetary policy review, the bank said headline inflation had peaked and with a decline in prices of non-food manufactured products, it was likely that inflation would stabilize at its current levels in the coming year.
"This provides space, albeit limited, for monetary policy to give greater emphasis to growth risks," it said.
The bank said it expected the interest rate cut to encourage investment and support growth.
Steps taken by the government including liberalization of foreign investment in retail, aviation, broadcasting and insurance should help return the economy to a higher growth trajectory, the RBI said.
Analysts cautioned that with India scheduled to hold general elections in 2014, there was a likelihood of further government sops leading to increased inflation and spending blowouts.
Abheek Barua, chief economist at HDFC Bank, said the funding situation of banks is very tight and there is a limit to which they could pass on the central bank's lower interest rate.
"The cut in the cash reserve ratio helps the situation only at the margins. Coupled with policy rate cuts, we might see small changes in consumer borrowing costs over the next few months," he said. "Nothing dramatic will happen unless the RBI follows through with a series of cuts and adds more liquidity to the system."