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Amid a worsening global economic downturn, India as raised the repo rate under the liquidity adjustment facility (LAF) by 25 basis points to 8.50 percent.

Dr. D. Subbarao, Governor of the Reserve Bank of India says the decision to persist with monetary tightening has been influenced by high inflation and moderated growth.

"While the impact of past monetary actions is still unfolding, based on our growth-inflation dynamics, we considered it necessary to persist with the anti-inflationary stance," says Subbarao.

The move is expected to result in 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.

The growth of the Indian economy decelerated to 7.7 percent in the April-June quarter of 2011-12 from 7.8 percent in the previous quarter. Industrial growth, as measured by the index of industrial production, decelerated to 5.6 percent during April-August 2011, down from 8.7 percent in the corresponding period of last year. 

In its May Statement and the July Quarterly Review, the Reserve Bank projected GDP growth of 8.0 percent for 2011-12. The mid-quarter review of September, however, pointed out that the risk to the growth projection was on the downside.

Based on the current and evolving macroeconomic situation, the central bank has revised downwards the baseline projection of GDP growth for 2011-12 to 7.6 percent.

"Controlling inflation is imperative both for sustaining growth over the medium-term, and for  increasing the potential growth rate," says Subbarao.

Subbarao adds that the challenge for the government and the Reserve Bank is to ensure that demand is constrained in the short term to bring inflation down, but at the same time to encourage supply response so as to improve productivity and expand the potential output of the economy in the medium term.

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