Mumbai: In a bid to tame inflation the Reserve Bank of India on Tuesday hiked key short-term rates to tame inflation, while giving respite to small savers by raising the savings rate to 4 percent from the current 3 percent. RBI signaled home, auto and other loans would also become costlier.

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 percent, 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 percent for 2011-12 as against the government's projection of 9 percent.

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

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.

The RBI Chief said over the long run, soaring inflation is inimical to growth, as it troubles investment by creating ambiguity.

"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.

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 cause greater social pressures," Ficci Director General Rajiv Kumar said.

The RBI, however, kept the Cash Reserve Ratio (the portion of cash banks are required to keep with the RBI) at 6 percent, 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 percent of their deposits at 8.25 percent.

The RBI also made out a case for hiking petroleum prices in line with global crude prices and said the government must act immediately to manage the fiscal situation.

"The critical assumption that petroleum and fertilizer subsidies would be capped is bound to be seriously tested at prevailing crude oil prices. Even though an adjustment of domestic retail prices may add to the inflation rate in the short run, the RBI believes that this needs to be done as soon as possible," RBI Governor Subbarao said.

Bankers said they are likely to hike interest rates on home, auto and corporate loans by half a percentage point as their cost of funds has gone up.

"I think banks do not have any other option but to increase rates. It could be 25 basis points or 50 basis points, depending on individual banks," IDBI Bank Executive Director RK Bansal said.