According to AppleInsider, a publication in Taiwan has reported that two companies have passed certification and are now preparing to ship panels for a forthcoming "iPad-mini" that's rumored to have a 7.85-inch display. This same report repeats the claim in an earlier report that the new panel will use "thin-film" touch technology, which allows for the iPad to be thinner and to cost less. There continue to be rumors that the new iPad will come out this fall, possibly as early as August, but more likely at the same time as the new iPhone 5 in October.
It will be interesting to see what happens. Should Apple come out with a smaller iPad or a larger iPhone, any such change is fraught with implications, not the least of which is the possibility that developers will have to rewrite all of their apps to fit the new size. Many developers have preferred to create apps for iOS devices because there were just two sizes. The Android world is much more complex, with various sizes and aspect ratios. An app for one Android device might not work on an Android device from another manufacturer.
iMore has a great article explaining the implications of an iPhone with a 4-inch screen. It clearly describes what options Apple has in going to a larger size, and how each option would impact developers.