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Interest rate hike was necessary, says FM

Finance Minister P Chidambaram says the steps taken by RBI were necessary to contain inflation that has scaled a 13-year high.

business Updated: Jun 25, 2008 13:45 IST

A day after the Reserve Bank of India (RBI) hiked its short-term lending rate and the minimum cash balance commercial banks have to maintain, Finance Minister P Chidambaram on Wednesday said the steps were necessary to contain inflation that has scaled a 13-year high.

"These steps are necessary in the face of rising inflation due to relentless increase in crude oil prices," Chidambaram said in a statement, as India's annual rate of inflation peaked to over 11 percent in recent weeks.

"These steps are expected to have a salutary effect," he said referring to the hike of 50 basis points in the repo rate and an equal increase in the cash reserve ratio that was announced by the central bank on Tuesday.

The immediate fall-out of the steps will be an upward revision in interest rates that is expected to hit not just the corporate sector, but also individual borrowers and those investing in stock markets. Interest rates on housing loans are also expected to go up.

The finance minister said there were also some positive factors for the economy, such as record production of rice and wheat and satisfactory stocks of food grain with the government for distribution to the needy through state-run shops.

"The objective of the RBI is to moderate and manage aggregate demand. The intention is to achieve the objective while ensuring that the prospects for overall economic growth remain positive," the finance minister said.

"The policy stance adopted by the RBI should boost the confidence of investors, both domestic and foreign, and augur well for economic growth."

The finance minister also pointed out that crude oil prices were rising relentlessly and that, prior to his meetings with oil producers and consumers in Jeddah last week, crude oil was trading at $136.63 to a barrel.

"This morning, it is US$136.80 per barrel."

The finance minister said the central bank's statement on Tuesday pointed out that demand was still high for credit off-take, the supply-demand balance was positive, domestic agricultural production was improving, the external sector was strong and resilient and foreign exchange reserves were comfortable.

The statement came after the central bank increased the cash reserve ratio of banks to 8.75 per cent in two stages and the repo rate (the rate at which commercial banks borrow from the central bank) to 8.5 percent in a bid to suck money out of the financial system and tame inflation.

"In view of the criticality of anchoring inflation expectations, a continuous heightened vigil over ensuing monetary and macroeconomic developments is warranted to enable swift responses with appropriate measures as necessary, consistent with the monetary policy stance," the RBI statement said.