All the six members voted in favour of the rate cut decision.
The Reserve Bank has warned however of risks to growth next year given the muted private investments and weak global demand coupled with geopolitical risks but is optimistic on meeting the Parliament-mandated inflation target of 2-6 per cent this financial year.
"The inflation outlook for 2016-17 has improved, but close vigilance is required to achieve the prospects of reaching 4 per cent. Robust consumption brightens the outlook for real gross value added growth in 2016-17, but muted private investment and weak global demand may restrain the pace of growth in 2017-18," the central bank said in the Monetary Policy Report ahead of the policy review decision.
Despite this warning, RBI has pegged the GVA growth of 7.6 per cent for the current fiscal and 7.9 per cent the year after.
Daily prices of sensitive items under pulses, fruits, vegetables and cereals suggest that the seasonal surge in food prices may have peaked in July, it said.
RBI expressed optimism that the trend may continue given the subdued momentum in food inflation in Q3 and the usual seasonal softening of food prices in early Q4, notwithstanding a reversal of base effects in March 2017, which in effect improves the near-term outlook for inflation considerably.
It also expects the commodity prices to remain under check during the remaining quarters of the year.
The central bank is basing its optimism to the improved household expectation on prices. In the September round of inflation expectation survey of the RBI which has found it to be 9.5 per cent in Q3 against 11.4 per cent a year ago. By contrast, producers’ inflation expectations appear to be more forward-looking.
The September round of RBI’s industrial outlook survey reveals an increase in the proportion of respondents expecting higher input prices in Q3. The survey also indicates a decline in their expectations of higher selling prices.
The September round of the professional forecasters’ survey also indicates a greater degree of anchoring of their inflation expectations, relative to other agents, around the RBI's inflation targets.They expect inflation to ease to 4.7 per cent in Q4 of this fiscal year and to 4.4 per cent by Q2 of 2017-18.
RBI said these projections incorporate the 7th pay commission award relating to salaries and pensions which will work through aggregate demand and expectations effects to add around 10 bps to the baseline path from Q4 of 2016-17.
Furthermore, the projections also factor in cost-push effects of the proposed increase in minimum wages which would add 5 bps to baseline inflation within two months of implementation.
On the impact of GST on inflation, the report notes that based on the current reckoning, the pass-through of the goods and services tax will likely commence from April 2017 and last for about 12-18 months, going by the cross-country experience.
The MPR said: "While the impact of the GST on CPI inflation would largely depend on the standard rate decided by the GST Council, almost 50 per cent of the CPI is expected to be exempt. Cross-country experience indicates that GST implementation might have one-off effects, which tend to dissipate after a year of its implementation."
On growth, the report said satisfactory monsoons and the implementation of the seventh pay hikes are expected to provide a boost to consumption spending, both rural and urban.
The survey conducted in August-September found consumer optimism on the general economic outlook, but somewhat less confidence on future income and employment.
While private investment activity remains sluggish, corporate business expectations remain upbeat in the Reserve Bank’s industrial outlook survey on improving prospects for production, capacity utilisation, employment and the availability of finance, the report noted.
"Over the medium-term, GST implementation should boost business confidence and investment, brightening the environment for an acceleration of growth," it said.
Other initiatives likes steps to attract FDI in defence, civil aviation, pharma and broadcasting, measures to improve infrastructure, and the enactment of the Insolvency and Bankruptcy Code and the Real Estate (Regulation and Development) Act should also contribute to unlocking entrepreneurial energies and growth impulses, it added.
On the global headwinds to growth, the report lists the outcome of the November 8 American presidential polls apart from the US Fed rate hikes.
"Consequently, spillovers purvey volatility to global and domestic financial markets, especially in the foreign exchange, equity and debt segments, with implications for domestic inflation and growth," it warned.