In a major policy decision, Reserve Bank Governor Duvvuri Subbarao also deregulated savings bank deposit rates with immediate effect.
"Changing the policy stance when inflation is still far above the tolerance level entails risks to the credibility of the Reserve Banks commitment to low and stable inflation," the policy document said, even as it admits that growth momentum has slowed down.
It said inflation will start cooling by December this year and is likely to come down to 7 percent by March, 2012.
Tuesday’s hike is the 13th since March, 2010. The series of rate hikes has cumulatively increased interest rates by 525 basis points.
The policy is expected "to continue to anchor medium term inflation expectations", while stimulating investment activity to support growth.
Borrowers, who are livid at repeated rate hikes, can heave a sigh of relief as the RBI hinted at a reversal of policy stance by saying the likelihood of a hike in December is "relatively low".
The Reserve Bank of India (RBI) has kept other key rate and ratio-- bank rate and cash reserve ratio (CRR)-- unchanged at 6 percent each. It also retained the statutory liquidity ratio (SLR) at 24 percent.
Factors like weakening global macroeconomic outlook and high domestic inflation will pull down the economic growth rate further, RBI said while lowering the GDP forecast for the current fiscal to 7.6 percent from its earlier projection of 8 percent.
The risks to the policy emanate from worsening global macro scenario, commodity prices and increase in government spending which could crowd out private investment, it said.
An important policy decision RBI announced on Tuesday is the freeing of savings bank deposit rates with immediate effect, the last bastion of the regulated interest rate regime.
Earlier in May, RBI had raised the savings deposit rates to 4 percent from 3.5 percent.
Giving banks the freedom to fix the savings accounts interest rate, RBI said banks will have to offer uniform rate on deposits of up to Rs one lakh.
On higher amounts, they can give differential rates to depositors. It has also permitted commercial banks to open branches in tier II cities without prior approval of RBI.
The Reserve Bank has also proposed to notify banning prepayment penalty on floating rate home loans, as recommended by the Banking Ombudsman recently.
The policy document further said that RBI will issue the final guidelines on credit default swaps by November-end.
As banking system prepares to go on to the Basel-III framework requiring higher capital adequacy, the RBI said the draft guidelines for its implementation will be issued by December-end.
As regards the micro finance sector, RBI has given the go-ahead for creating a new category called NBFC-MFIs