SWMAE03, encoding altimeters normally use a separate 'altimeter' which is always set to 1013.25mb. Conversion to altitude on a radar display is done by the display processors. Although I don't know what it is, I'm sure that there is an accuracy requirement specified. As some of the other posts have mentioned ATC procedures allow a bit of 'slack'. If you've listened to ATC radar frequencies (particularly departure frequencies) you'll have controllers asking pilots to report their level or passing level. If the radar readout is within 200 ft of what the pilot says all is well. If after trying again (ideally when the aircraft is in level flight) the readout is still not within 200 ft the pilot should be told to switch off the mode C (altitude) reporting.