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August 4, 2000
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Rate hike will not hurt economy, says Jalan

Reserve Bank of India Governor Bimal Jalan said on Friday he did not expect an interest rate hike announced two weeks ago to retard economic growth.

Jalan told a news conference he expected the interest rate rise and liquidity squeeze measures announced on July 21, to defend the rupee and adjust to changed international and domestic market conditions, to work over a period of time.

Indian industrial output growth slowed in April and May, well before the RBI hiked rates and squeezed liquidity, and banks were still flush with funds to lend, Jalan said.

"I don't think so (that it will have any impact on industrial activity)," Jalan said in answer to a question on whether the July hike in interest rates would economic growth.

"There's plenty of money available," he said.

The rupee breached the 45 per dollar for the first time on July 21, extending a two-months gradual decline, and is down slightly more than four percent against a globally strong US currency.

The RBI announced a hike in banks' cash reserve ratio (CRR) by 50 basis points to 8.5 per cent in two stages, effective on July 29 and August 12, and raised the bank rate by one percentage point to 8 per cent.

The central bank also reduced limits available to banks for refinance facilities by 50 per cent in two stages.

The rupee began falling again after a brief respite following the moves and on Friday it ended at a fresh low of 45.42/43.

Jalan said he had never expected an immediate result, but believe the July 21 measures to have the desired effect over time.

"We were not expecting immediate results," Jalan said, adding, "That is why we spread it over a month."

"If we had felt very uncomfortable on July 21, we would have taken much harsher measures," he added.

Jalan said he fully accepted that the transactions in the foreign exchange market reflected genuine importer and exporter demand.

He said exporters who had not been given approval to hold their receipts in foreign currency had now converted their earnings to rupees.

Some of the volatility in the rupee, which is convertible only on the current account, had been caused by a bunching of importer demand, he said.

"At the present time, not being fully convertible is a help because the volatility is much less," Jalan said.

The RBI governor expected foreign direct investment inflows to accelerate as telecom, power and road-building projects took off.

He said the current volatility in currency markets was not just an Indian problem, but it posed more difficulties for emerging market economies than developed nations.

The central bank said the interest rate rise was partly aimed at maintaining differentials with the United States and encouraging local firms to switch to rupee assets.

Jalan said the RBI would act independently and there would be no automatic response to any change in international interest rate trends.

"We would have to assess the situation," he said.

The US Federal Reserve meets on August 22, and there is speculation in markets that it may raise rates again.

Jalan reiterated that in an ideal situation the RBI would like low real interest rates.

He did not believe that the recent dip in the rupee would fuel inflation, which is currently running at around 6 per cent annually, based on wholesale prices.

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