The US Federal Reserve has been raising key rates and the European Central Bank has given indications of raising rates.

When the rates the world over are moving upwards, India cannot remain insulated from its effect, Rajan said after delivering a lecture on financial development at the Reserve Bank of India [Get Quote].

Rajan said the supply of liquidity worldwide is being slowly withdrawn. There is a shift now from extreme accommodative approach to liquidity tightening. Bank of Japan is expected to join the US Fed and the ECB soon by increasing its rates.

The Reserve Bank of India hiked the reverse repo rate by 25 basis points each on three occasions, amply indicating the change in the interest rate cycle.

Commercial banks have not been behind in revising rates. They (banks) have revised rates - deposits and lending - by 25-50 basis points in the recent past.

Referring to growth prospects for the Indian economy, Rajan said the country's gross domestic product is expected to grow at a lower rate of 7-7.5 per cent in 2006.

The country has to fix the fiscal deficit problem and push economic reforms further to step up economic grow rate beyond 7.5 per cent.

The combined fiscal deficit has been brought down from 10 per cent to 7-8 per cent and there is a planned pause on this. The country will have to attack subsidies to free resources for education, health and employment generation schemes, Rajan said. 

The global hike in crude oil prices can be fully passed through to those consuming petroleum products. Those who use cars are in a position to afford hike in fuel prices and the poor could be provided support through coupon system, he added.