RBI has, however, lowered the GDP growth estimate from 8 to 7.6 per cent in view of both domestic factors and global slowdown and the cumulative impact of monetary actions thus far. The increase in the key policy lending rate by a quarter-percent would result in the reverse repo rate adjusted to 7.5 per cent and the marginal adjustment facility at 9.5 per cent.

The Governor Dr Subbarao also announced deregulation of savings bank deposit interest rate (which had recently been pegged at 4 per cent) with immediate effect. Banks would be free to determine their savings bank deposit interest rate, subject to two conditions: Each bank will have to offer a uniform interest rate on savings bank deposits up to Rs. one lakh, irrespective of the amount in the account within this limit. Differential rates of interest may be provided for deposits of over one lakh, if the bank so chooses.

Explaining the rationale of current monetary tightening, the policy review said both inflation which is broadbased, and inflation expectations remain high and above the comfort level of the Reserve Bank.” We expect these levels to persist for two more months. There are potential risks of expectations becoming unhinged in the event of a pre-mature change in the policy stance”

However, moderation is indicated in the de-seasonalised quarter-on-quarter headline and core inflation measures and it is consistent with the projection that inflation will decline beginning December 2011. Secondly, growth is clearly moderating on account of the cumulative impact of past monetary policy actions as well as some other factors.

As inflation begins to decline, there will be “growing room for the policy stance to give due consideration to growth risks, within the overall objective of maintaining a low and stable inflation environment” the Governor said. The projected inflation trajectory indicates that the rate will begin falling in December 2011 and then continue down a steady path to 7 per cent by March 2012. It is expected to moderate further in the first half of 2012-13. This reflects a combination of commodity price movements and the cumulative impact of monetary tightening.

These expected outcomes provide some room for monetary policy to address growth risks in the short run. Thus, notwithstanding current rates of inflation persisting till November, RBI says, the likelihood of a rate action in the December mid-quarter review is “relatively low.” Beyond that, if the inflation trajectory conforms to projections, further rate hikes may not be warranted. However, as always, actions will depend on the evolving macroeconomic conditions.

RBI says today’s policy action would lead to three outcomes. First, on the basis of a credible commitment to low and stable inflation, medium-term inflation expectations will remain anchored. Second, the emerging trajectory of inflation, which is expected to begin to decline in December 2011, will be reinforced, and, finally, it will contribute to stimulating investment activity.

Going outside the ambit of monetary policy, RBI points out, several factors – structural imbalances in agriculture, infrastructure capacity bottlenecks, distorted administered prices of several key commodities and the pace of fiscal consolidation – combine to keep medium-term inflation risks in the economy high.

These risks can only be mitigated by concerted policy actions on several fronts. In the absence of progress on these, over the medium term, the monetary policy stance will have to take into account the risk of inflation surging in response to even a moderate growth recovery, the policy statement cautions.

Going forward RBI said, the inflation path would depend on the extent of moderation in aggregate demand. Some signs of demand moderation are evident, although the impact is being felt more on the investment side. Second, the behaviour of crude prices will be a crucial factor in shaping the outlook of domestic inflation in the near future. The benefit of a decline in global crude prices in the recent period has been more than offset by the depreciation of the rupee in nominal terms. Thus, the exchange rate will also have some impact on the behaviour of domestic petroleum prices.

Third, the inflation outlook will also depend on the supply response in respect of those commodities characterised by structural imbalances, particularly protein items. Finally, there is still an element of suppressed inflation in the economy. Domestic prices of administered petroleum do not reflect the full pass-through of global commodity prices. Prices of coal and a few other commodities do not reflect the current market conditions. As and when price adjustments take place, they will add to inflationary pressures.

In its survey of macro-economic and monetary conditions ahead of today’s announcement,, RBI listed the upside risks from the still incomplete pass-through of global commodity prices, downward stickiness of food prices, recent revisions in minimum support prices and evidence of wage price spiral. Headline inflation has now stayed in 8-11 per cent range for the past 21 months and non-food manufacturing inflation has been more than 7 per cent for the past eight months against a long-term average of 4.4 per cent.

Pointedly, RBI said fiscal slippages may complicate the task of aggregate demand management. Currently, government spending is adversely impacting the objective of containment of aggregate demand and the assessment is that the deficit targets are unlikely to be met for 2011-12. While a growth slowdown would impact revenues and tax cuts will be difficult to boost the economy, given the macro-economic consequences of fiscal position on interest and exchange rates and price level, it is important to create fiscal space within the framework of fiscal rules, RBI said. (IPA)