The Reserve Bank of India (RBI) has decided to increase the repo rate by 25 basis points to 6.25 percent and reverse repo rate by 25 basis points to 5.25 percent on Tuesday.

"These changes will be with immediate effect," the RBI said while announcing the second quarter monetary policy review here on Thursday.

However, the RBI has retained the cash reserve ratio (CRR) of scheduled banks has been at 6.0 percent of their net demand and time liabilities (NDTL).

RBI said this rate hike to contain inflation and anchor inflationary expectations, while being prepared to respond to any further build-up of inflationary pressures, to maintain an interest rate regime consistent with price, output and financial stability and to actively manage liquidity to ensure that it remains broadly in balance, with neither a surplus diluting monetary transmission nor a deficit choking off fund flows.

On the domestic front, RBI said first quarter estimated growth rate at 8.8 percent indicates that the recovery is consolidating and the economy is rapidly converging to its trend rate of growth driven mainly by domestic factors.

"The headline inflation has moderated in recent months, the current rate of inflation is still well above the comfort zone of the Reserve Bank," said the RBI.

This is the sixth rate hike this year by the RBI. Since October 2009, the RBI has cumulatively raised the cash reserve ratio (CRR) by 100 basis points, and the repo and reverse repo rates under the LAF by 125 basis points and 175 basis points, respectively.

As per the new WPI series, the year-on-year inflation moderated to 8.5 per cent in August 2010 and 8.6 per cent in September 2010 after remaining in double digits during March-July 2010.

Taking into account the good performance of the agriculture sector, a range of indicators of industrial production and service sector activity amidst the prevailing global macroeconomic scenario, the baseline projection of real GDP growth for 2010-11, for policy purposes, is retained at 8.5 per cent, as set out in the July 2010 review.

India’s growth of 8.8 percent in Q1 of 2010-11 suggests that the financial recovery set in the second half of 2009-10 is consolidating due to delay in withdrawl of normal south-west monsoon boosted the prospects of both kharif and rabi agricultural production.

With a view to alleviating frictional liqudity pressure, the RBI decided to conduct second LAF (SLAF) and also allowed scheduled commercial banks to avail of additional liquidity support under the LAF to the extent of up to 1.0 percent of their NDTL as on October 8, 2010.

During 2010-11 so far (October 22, 2010), the rupee appreciated by 0.4 percent on the basis of trade based 36-currency real effective exchange rate (REER). The extent of appreciation was, of course, higher on the basis of 6-currency trade based REER (3.1 percent) reflecting both the nominal appreciation of the rupee against the US dollar during this period and the higher inflation differential with major advanced countries, said the RBI.

"The interest rate increases are expected to sustain the anti-inflationary thrust of recent monetary actions and outcomes in the face of persistent inflation risks, to rein in rising inflationary expectations, which may be aggravated by the structural nature of food price increases.and to be moderate enough not to disrupt growth," added the RBI statement.

Inflation remains high. Both demand side and supply side factors are at play. Inflationary expectations also remain at an elevated level. Given the spread and persistence of inflation, demand side inflationary pressures need to be contained and inflationary expectations anchored. To ensure that economic activity is not disrupted by liquidity constraints, the liquidity deficit needs to be contained within a reasonable limit, the RBI said while raising the repo and reverse repo rates to 6.25 percent and 5.25 percent, respectively.

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