The Reserve Bank today termed the government decision to hike diesel prices a "significant achievement", but said the move will put pressure on inflation in the short term.
"While the recent upward revision in diesel prices and rationalisation of subsidy for LPG is a significant achievement, in the short-term, there will be pressures on headline inflation," RBI Governor D Subbarao said.
The government had last week hiked diesel prices by Rs 5.63 a litre and capped the number of subsidised LPG cylinders to six per family a year.
In RBI's mid-quarterly policy review, Subbarao said, "Over the medium-term, it (government move) will strengthen macroeconomic fundamentals".
RBI further said that over the longer run, subsidies should be brought down to below 2 per cent of GDP as indicated in the Budget to manage the demand side pressure on inflation.
"Containing inflationary pressures and lowering inflation expectations warrant maintaining the momentum of recent policy actions to step up investment, alleviate supply constraints, and improve productivity," Subbarao said.
The government has already taken a slew of reform measures including allowing FDI in multi-brand retail, and foreign carriers to pick up stake up to 49 per cent in aviation companies. Besides, it also cleared minority stake sale in four public sector companies.
Subbarao said, "Domestically, growth continues to be weak amidst a negative investment climate; however, the recent reform measures undertaken by the Government have started to reverse sentiments.
"Steps taken to increase foreign direct investment (FDI) should contribute to both greater capital inflows and, over the long run, higher productivity, particularly in the food supply chain."
In its mid-quarterly monetary policy review announced earlier in the day, the RBI lowered cash reserve ratio (CRR), the portion of deposits banks park with RBI, by 0.25 per cent to 4.5 per cent. CRR reduction would infuse Rs 17,000 crore into the financial system.
The RBI, however, kept short-term lending and borrowing rates unchanged, disappointing India Inc.
Subbarao said persistent inflation remains a challenge for the RBI and risks to growth remains.
"Several challenges remain, one of which is persistent inflation. But, as policy actions to stimulate growth materialise, monetary policy will reinforce the positive impact of these actions while maintaining its focus on inflation management," he said.
The overall inflation rose to 7.55 per cent in August, from 6.87 per cent in July. This is much above the RBI's comfort level of 5-6 per cent.
Subbarao further said that economic growth is likely to remain subdued in the July-September quarter of the current fiscal. The economic growth had fallen to 5.5 per cent in April-June quarter, from 8 per cent in the corresponding period a year ago.