The Reserve Bank of India (RBI) said a weaker economy had pushed it to make the cut outside its scheduled policy meeting.
The move strengthened investor confidence, sending the rupee higher against the dollar, and sending Indian bonds up sharply. For the first time, the BSE index topped 30,000, up 0.5 per cent.
The decision came a few days after Narendra Modi's first annual budget, and shortly after the bank moved to introduce inflation targets.
Analysts suggested the move could precipitate further rate cuts over the next few months. In a note, Standard Chartered said:
The surprise rate cut by the RBI should be a short-term positive for the Indian rupee, as it will support growth-sensitive inflows. Markets are also likely to take the view that the RBI is not overly concerned with the slightly higher fiscal deficit targets for the next two fiscal years announced in the budget last week.As such, expectations of further rate cuts could build, which would further weigh on [the rupee]. At the same time, we expect the RBI to continue its intervention in the foreign exchange markets and aim to contain excessive trade-weighted rupee appreciation.