* MSF rate cut is latest move by new central bank head to normalise policy
* Traders see bond yields falling about 20 bps on Tuesday
* Fed stimulus, U.S. debt crisis have helped ease pressure on rupee (Repeats to detach from previous item)
By Suvashree Dey Choudhury and Neha Dasgupta
MUMBAI, Oct 7 (Reuters) - India's central bank cut an overnight interest rate on Monday, further unwinding extraordinary measures taken to defend the rupee as pressure on the embattled currency eases.
The 50-basis-point cut in the Marginal Standing Facility (MSF) rate to 9.0 percent will increase market liquidity and is the latest move by new Reserve Bank of India (RBI) Governor Raghuram Rajan to roll back some of the measures put in place to support the rupee.
The Indian currency had dropped as much as 20 percent in the first eight months of the year.
"I think RBI is getting more confident about the stability of the rupee and that is the reason they cut the MSF rate now," said Manish Wadhawan, head of trading at HSBC in Mumbai.
India's record-high current account deficit made it especially vulnerable an the exodus of funds from developing markets earlier this year.
But the rupee has risen sharply in recent weeks, reflecting an easing of those pressures as the U.S. Federal Reserve delayed cutting back the stimulus programme that had fed emerging market investments and debt talks in Washington ground to a halt.
The RBI jacked up the MSF rate by 200 bps in mid-July in an attempt to soak up short-term market funds and make it harder to speculate against the rupee.
That move, the most dramatic in a package of measures to defend the currency, saw the MSF replace the repo rate as India's de facto policy rate.
Monday's partial reversal "will lead to a rally in the short-term rates and I expect the G-sec (government bond) curve to steepen and the inversion will correct," Wadhawan said.
He said he expected the RBI to cut the MSF by a further 50 bps at its October policy review and leave the repo rate unchanged.
Since hitting a record low 68.85 to the dollar on Aug. 28, the rupee has gained 11.4 percent and closed on Monday at 61.79 per dollar. Traders said bond yields could fall by roughly 20 bps on Tuesday following the RBI's move late on Monday.
Rajan, a high-profile former chief economist at the International Monetary Fund, took over at the central bank on Sept. 4.
In his first monetary policy review last month, he cut the MSF rate by 75 bps while unexpectedly raising the repo rate by 25 bps to 7.50 percent. He also said he wanted the repo rate to regain its role as the policy rate.
Rajan has also taken steps to lure dollar inflows, including last month offering concessional forex swap rates. These had drawn $5.7 billion as of Monday and are expected by bankers to bring in a total of about $15 billion by the time the programme ends next month.
"Even if the Fed starts tapering, India will be in a better state to handle that, given that by that time a reasonable amount of money would have come in through the swap windows," said A. Prasanna, economist at ICICI Securities Primary Dealership in Mumbai.
He said he expected the RBI to raise the repo rate by a further 50 basis points by the end of December.
Indian economic growth languished near its slowest in three years at 5.5 percent in the quarter that ended in June but was slightly better than expected, signalling the worst may be over for Asia's third-largest economy.
Lowering the MSF rate makes funds cheaper for banks, thereby making credit more accessible to borrowers just as India enters the festive season, which typically sees heavy spending on big-ticket items such as cars and appliances.
Normally, the MSF rate is 100 bps higher than the repo rate. Monday's move narrows the gap to 150 bps. (Writing by Tony Munroe; Editing by John Stonestreet)