Home, auto and other loans are set to become costlier with the Reserve Bank today hiking key short-term rates to contain inflation, while giving relief to small savers by increasing the savings bank rate to 4 per cent from 3.5 per cent now.

The signal was given by the RBI in its annual policy review meeting for 2011-12, where it hiked the repo rate (the rate at which banks borrow from the RBI) by 50 basis points to 7.25 per cent, the ninth increase since March, 2010.

RBI governor D Subbarao made it clear that containing inflation would take precedence over growth, which has been pegged at a lower level of 8 per cent for 2011-12 as against the government's projection of 9 per cent.

The move to hike the rates has been necessitated as the RBI feels inflation would remain at an "elevated level" of 9 per cent in the first half of the current financial year before moderating to 6 per cent by March, 2012.

Subbarao's hawkish stance was supported by finance minister Pranab Mukherjee, who said, "This (hike in rates) was necessary to contain inflation. Inflationary pressure in the economy is still very high."

Planning commission deputy chairman Montek Singh Ahluwalia also endorsed the RBI stance and welcomed the hike in both the lending rate as well as the savings rate.

"Personally, I am very glad that the RBI has given a clear signal going beyond the usual 25 basis points (revision)," he added.

The RBI chief said over the long run, high inflation is inimical to growth, as it harms investment by creating uncertainty.

"Current elevated rates of inflation pose significant risks to future growth. Bringing them down, therefore, even at the cost of some growth in the short run, should take precedence," he added.

Most bankers felt there was no option but to increase interest rates as the cost of borrowing funds has also gone up, with the RBI hiking the short-term lending rates.

However, the industry is disappointed. "This is certainly a very hawkish monetary stand, which would make the investment environment even more difficult... We are afraid that with growth slowing down, employment targets will not be achieved and this could generate greater social pressures," Ficci director general Rajiv Kumar said.

But industry body Assocham (Associated chambers of commerce and industry) sees in it a concerted and determined effort of the bank to rein in inflation and has called it an aggressive, matured and caliberated move.
 
"This is in line with market expectations to transmit clear signals that drousing inflation has overtaken priority of moderating medium-term growth," said Dilip Modi, president of Assocham. “The step is positive in addressing demand-side pressures as lending rates are bound to go up, thereby cooling down the growth momentum but not on a large-scale,” he added.

The leading industry chamber believes that the the central bank has been prompted to take such a  step amidst growing concern of a continuous negative return. It also supports the increase in savings bank deposit interest from 3.5 per cent to 4 per cent as announced by the RBI in it's annual  policy. "This increase in savings bank deposit interest with immediate effect is well within the current thinking of deregulating it," said Assocham.

"Sustained monetary tightening will make borrowings costlier and compress demand side pressures. The RBI has continued to follow its policy of calibrated monetary tightening in view of rising inflation much above its comfort zone," said Modi.
 
According top the chamber, by moderating inflation and anchoring inflationary expectations, the new interest rate environment will foster price stability. "It will neither choke funds flow nor create large surpluses in the system," said the Assocham president.
 
The industry body hopes  that the RBI's move to adopt repo rate as the reference rate and link reverse repo with 100 basis points spread will hasten transmission of policy rates in the entire banking system.

The RBI, however, kept the Cash Reserve Ratio (the portion of cash banks are required to keep with the RBI) at 6 per cent, ensuring sufficient liquidity in the system.

The central bank also introduced a new mechanism -- Marginal Standing Facility -- under which banks would be permitted to borrow short-term funds (overnight) up to 1 per cent of their deposits at 8.25 per cent.

(With inputs from PTI)