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Reserve Bank of India Governor Duvvuri Subbarao.© Danish Siddiqui / Reuters/Reuters

India's central bank cut interest rates for the first time in nine months Tuesday and lowered the amount of cash banks must keep in reserve as it looks to boost investment and kickstart the flagging economy.

But while responding to demands from the government and business leaders for lower borrowing costs, the Reserve Bank of India (RBI) ruled out deeper cuts as inflation remained too high for comfort.

"Inflation pressures appear to have peaked. Economic activity has slowed and it needs new investment," RBI governor Duvvuri Subbarao said in a statement, which he read on television.

He added that there was "limited" room for large cuts this year.

"There is an increasing likelihood of inflation remaining rangebound around current levels going into 2013-14. This provides space, albeit limited, for monetary policy to give greater emphasis to growth risks," Mr. Subbarao said.

Economists had widely expected the cut of 25 basis points that will see the benchmark repo rate, at which the RBI lends to commercial banks, fall to 7.75 per cent.

The bank also cut its cash reserve ratio – which determines the amount of cash banks must keep aside – by 25 basis points to 4.0 per cent.

The move will inject 180 billion rupees ($3.3-billion U.S.) into the banking system, encouraging commercial banks to lend, Mr. Subbarao said.

Analysts said Tuesday's moves would provide a trigger for investment and growth, but said future rate cuts would depend on whether the government continues a recent pro-market reform drive and efforts to cut subsidies.

"Tuesday's moves are a beginning," Shubhada Rao, chief economist with private Yes Bank told AFP.

The RBI will eye the government's federal budget later next month to decide on a future course of action, she said.

The Congress-led government has introduced a string of new measures since September to encourage foreign investment in key sectors of the economy and reduce its subsidies, which have led to a ballooning fiscal deficit.

Indian shares, which had opened weak, were up 0.24 per cent at noon.

The Prime Minister's top economic adviser C. Rangarajan told CNBC-TV18 the RBI's moves would "provide a stimulus to economic growth" and rates may dip further if inflation continues to ease.

India's inflation eased to a three-year-low of around seven per cent in December, but is still above the bank's comfort zone of around 5 per cent.

China, South Korea and Brazil have all cut interest rates to shield their economies from the effects of the euro zone debt crunch.

Indian business leaders and the government have for months been calling for lower lending rates to help the economy, which grew at just 5.3 per cent in the quarter to September.

The central bank on Tuesday lowered its growth estimate for the fiscal year ending March to 5.5 per cent from its earlier forecast of 5.8 per cent.

It said it now expects inflation to ease to 6.8 per cent by the end of the fiscal year, against its earlier forecast of 7.5 per cent.

Until Tuesday's move, the RBI had kept rates unchanged since April last year saying inflation needed to fall further and government spending needed to be curbed.

In a report on Monday, the RBI said the reform measures announced so far have not decisively lifted business sentiment and more "action may be needed" to restore confidence.