The central bank cut its key repo rate to 7.25% from 7.50%, as widely expected, after taking similar moves in January and March this year. The repo rate is the level at which the central bank lends to commercial banks.
The cut comes despite India becoming the world's fastest-growing major economy, beating China recently.
The Indian economy grew by 7.5% in the January to March period compared with a year ago, outstripping the 7% figure for China, the world's second largest economy.China has also cut interest rates three times in the past six months.
Inflation watch
Despite the strong growth, analysts have pointed to other economic indicators which suggest soft patches in India's economy.
Other data released on Tuesday - such as the MNI consumer sentiment indicator - fell by 2% in May from April, indicating that consumers were less optimistic about the economy.
"With low domestic capacity utilisation, still mixed indicators of recovery, and subdued investment and credit growth, there is a case for a cut in the policy rate today," the central bank said in a statement. Added to that, consumer price inflation hit a four-month low of 4.87% in April - within the central bank's target range of 2% to 6% - which gave it enough room to ease rates, economists said.
However, the central bank warned that it would track inflation data and keep a close eye on risks to food prices if seasonal monsoon rains were weaker than expected, global oil prices recovered or the local currency weakened from volatile global markets.
"I think the implication of the guidance is that the RBI is going to wait for more inflation data and also for more clarity on risks to inflation," A. Prasanna, an economist at ICICI Securities Primary Dealership, told Reuters.
"We hold to our call that the RBI will be on pause for the rest of the year until December." Despite the expected rate cut from the central bank, Indian shares fell with the benchmark BSE Sensex index down 1.5% to 27,444.88.
bbc.com
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