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RBI warns of tough times; raise key rates by 50 basis points

In a bid to contain inflation, the central bank has raised its short-term lending rate by 50 basis points to 7.25 per cent, while lowering the economic growth projection to 8 per cent for 2011-12.

Warning of tough times ahead, the RBI on Tuesday raised the key short term lending rate and savings bank rates by 50 basis points and advised the government to hike petroleum prices as soon as possible in line with the ruling global crude prices.

In view of uncertainty prevailing in the global market, the RBI, while announcing its annual Credit Policy, has pegged the growth outlook for 2011-12 at a lower level of 8 per cent as against the government's projection of 9 per cent.

The RBI's decision to increase its lending (repo) and borrowing (reverse repo) rates by 50 basis points to 7.25 per cent and 6.25 per cent respectively will raise the cost of home, auto and other loans.

"Current elevated rate of inflation pose significant risk to future growth. Bringing them down, therefore, even at the cost of some growth in the short run should take precedence," RBI Governor D Subbarao said.

The current inflation is hovering around 9 per cent, much above the RBI's comfort level of 5-6 per cent.

Commenting on the RBI policy, Finance Minister Pranab Mukherjee said "this (rate hike) was necessary to contain inflation. Inflationary pressures to the economy are still very high".

The RBI, however, gave much required relief to general depositors by increasing the savings bank rate to four per cent from 3.5 per cent now. This would also have a bearing on the lending rates of the banks.

Making a strong case for increasing the petroleum prices in line with the global crude prices, the RBI said that any delay would widen the fiscal deficit and counter the moderating trend in aggregate demand.

"Even though an adjustment of domestic retail prices may add to the inflation rate in the short run, RBI believes this needs to be done as soon as possible. Otherwise, the fiscal deficit will widen and will counter the moderating trend in aggregate demand," Subbarao said.

Justifying the hawkish policy stance, the RBI said "resurgence of inflation in the last quarter of last year became a matter of concern".

Subbarao further said the recent surge in global commodity prices are likely to continue during the course of the year. "This suggests that higher inflation will persist, and may get worse".

While raising the key policy rates, the RBI retained the bank rate at 6 per cent and the Cash Reserve Ratio (CRR) also at 6 per cent. The CRR is the portion of deposits the banks are required to park with the RBI.

Retaining CRR at 6 per cent would ensure sufficient liquidity in the system.

The Central Bank has pegged the March 2012 inflation at 6 per cent with an upward bias. "As regards the trajectory over the year, inflation is expected to remain at an elevated level in the first half of the year before gradually moderating to 6 per cent by March 2012," it added.

The RBI also introduced a new mechanism -- Marginal Standing Facility -- under which banks would be permitted to borrow short term funds up to one per cent of their deposits at 8.25 per cent.