The repo rate at which the central bank lends to commercial banks has been raised from 5.75 to 6 per cent while the reverse repo rate has been increased by 50 basis points to 5 per cent. Both new rates come into immediate effect.

RBI's move is in line with expectations as despite an one percentage point plus reduction in WPI in August, it notes inflation trends under both the new (2004-05 - base year) and old series are broadly identical, even if inflation may have reached a plateau.

For the first time, RBI has been more explicit on deposit growth deceleration in juxtaposition with some buoyancy in credit growth for several months. 'One important consequence of negative real rates is that banks have seen a deceleration of deposit growth, as savers look for higher returns elsewhere. If bank credit is not to become a constraint to growth, real rates need to move in the direction of encouraging bank deposits'

How far banks follow the signal and how soon remains to be seen. But the banking system is no longer as flush with excess liquidity as was the case last year. Liquidity, RBI says, has been a significant factor in monetary policy considerations in recent months. The lead-up to the July policy review saw the liquidity situation transit from a large surplus to a mainly deficit one, making the repo rate the operative policy rate. Consequent on this transition, the transmission from policy rates to market rates has strengthened and these circumstances are expected to prevail, maintaining the repo rate as the effective policy rate and sustaining the strength of the transmission mechanism

On economy's growth prospects, the review notes improved industrial performance in April-July period but ' the high volatility over the past two months raises some doubts about how effectively the index reflects the underlying momentum in the industrial sector' Monsoon has given a boost to growth outlook in agriculture, and, by virtue of substantial replenishment of reservoirs and ground water, will also contribute to a good rabi harvest. Virtually all leading indicators of service sector activity point to sustained growth.

Global economy is slowing down in the latter half of 2010 and is a cause for caution, but overall the big picture has not worsened since July, to pose risks of domestic slowdown. India's GDP growth was estimated at 8.8 in the first quarter of 2010-11. Although some of this is attributable to a favourable base effect, the growth rate indicates that the recovery is consolidating and the economy is rapidly converging to its trend rate of growth, RBI said.

Summing up, RBI considers that its latest measures should contain inflation and anchor inflationary expectations without disrupting growth, reduce the volatility in overnight call money rates, thereby strengthening the monetary transmission mechanism, and continue process of normalisation of monetary policy instruments.

Fiscal outlook suggests that there would be no risk of the targeted 5.5 per cent deficit overshooting. It should help stabilise market expectations of liquidity and interest rate movements.

Although trade deficit is widening, even with relative slowdown in world trade, RBI does not see any problem on the balance of payments front. The stabilisation in advanced economies visible over the past few weeks appears to have improved global investor sentiment, resulting in a steady increase in capital inflows into emerging economies including India.' If this trend continues, the risks on the external front will clearly abate despite exports remaining sluggish.'

RBI expects inflation to remain high for some months, despite signs of its ceasing to accelerate. Recent monetary actions have some impact on both inflationary expectations and demand without disrupting growth. At the same time, a possible firming of commodity prices and consequence inflationary pressures has to be kept in view, according to the review. (IPA Service)