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Raghuram Rajan keeps his promise

With his unscheduled rate cut, Rajan shows why we should be watching the data and not the calendar. What will be the impact on your fund investments?

In an unscheduled (we refuse to call it a surprise) early morning move, the Reserve Bank lowered interest rates, reducing the benchmark repurchase rate--commonly called the repo rate--to 7.5 percent from 7.75 percent.

In his statement, the RBI Governor indicated that he was happy with the government's fiscal control, but increasingly worried about the lack of growth.

"The fiscal consolidation program, while delayed, may compensate in quality, especially if state governments are cooperative," Rajan said in the statement. "Given low capacity utilisation and still-weak indicators of production and credit off-take, it is appropriate for the Reserve Bank to be pre-emptive in its policy action to utilize available space for monetary accommodation."

This is good news, tempered with bad news. The government is doing its bit, but the economy is not lifting as well as it should. The fact that Rajan thought it necessary to prepone the rate cut by a month (the next scheduled policy review is due on April 7) shows that the weak point in the Indian economy has shifted from inflation and government overspending to poor growth.

Impact on Mutual Fund Investors

Equity funds: Today, equity fund investors will have a great day. The Sensex cracked 30,000 in the morning. The clear sense that the RBI and the government are both on the same page and making strong efforts to revive the economy. This should keep investors interested and the markets strong, but of course the short term mood of the equity markets cannot be predicted.

Debt Funds: As usual, lower rates are a positive for longer maturity debt funds and there will likely be decent gains as an immediate results. However, investors should remember that in the long run, lower rates means lower returns. Even so, since the lower rates are preceded by lower inflation, real (inflation-adjusted) returns will likely be maintained or may even improve.