into law. maintaining price stability, as i am required to do, is different from firstly having to achieve it, as was required then. as you know, before becoming governor, i signed a new policy targets agreement with the minister of finance. this new agreement offers monetary policy a bit more scope to take evolving circumstances into account. in particular, the new agreement makes clearer that the reserve bank should maintain price stability in a flexible way that does not unnecessarily disrupt the real economy. the key change in the agreement is that the inflation target has been explicitly defined in terms of “ future inflation... on average over the medium term ”. this implies that monetary policy should be forward - looking, and avoid getting distracted by transitory fluctuations in the inflation rate. in typical circumstances, we expect to give most attention to the outlook for cpi inflation over the next three or so years. if the outlook for trend inflation over that period is inconsistent with the target, we will adjust the official cash rate. our intention will be that projected inflation will be comfortably within the target range in the latter half of the three year period. this means we will set policy so that inflation will be within the target range in the medium term, unless we are hit by a major surprise event. if a major surprise does occur, we will explain what has caused inflation to be higher or lower than we wanted, and what steps we will take to ensure that it goes back comfortably within the band. i said the new policy targets agreement offers us a little more flexibility, but it ’ s a flexibility that needs to be applied with care. the language of the new agreement makes clear that inflation should not be persistently outside either end of the band. this is because a sustained breach of the target could affect people ’ s perceptions of the trend inflation rate. that in itself could create a major inflationary problem. thus, if one of the disturbances i mentioned earlier appeared to be strongly stimulating or weakening activity in new zealand - suppose there was a sharp and persistent increase in tourist numbers for example - then the inflationary consequences might not be transitory. so, to keep inflation from rising and activity from going through a boom - bust cycle, monetary policy still needs to act to counteract the impact of these disturbances. and monetary policy still needs to respond particularly assertively when inflation is expected to be well outside the target range, or persistently outside it. but, at other times, if inflation is fairly stable and if we

appropriate level in line with the inflation differential to maintain the competitiveness of exports. subsequently, following the recommendations of the high level committee on balance of payments ( chairman : dr c. rangarajan ) the liberalised exchange rate management system ( lerms ) involving dual exchange rate mechanism was instituted in march 1992 which was followed by the ultimate convergence of the dual rates effective from march 1, 1993 ( christened modified lerms ). the unification of the exchange rate of the rupee marks the beginning of the era of market determined exchange rate regime of rupee, based on demand and supply in the forex market. it is also an important step in the progress towards current account convertibility, which was finally achieved in august 1994 by accepting article viii of the articles of agreement of the international monetary fund. the appointment of an expert group on foreign exchange ( popularly known as sodhani committee ) in november 1994 is a landmark in the design of foreign exchange market in india. the group studied the market in great detail and came up with far reaching recommendations to develop, deepen and widen the forex market. in the process of development of forex markets, banks have been accorded significant initiative and freedom to operate in the market. to quote a few important measures relating to market development and liberalisation, banks were allowed freedom to fix their trading limits, permitted to borrow and invest funds in the overseas markets up to specified limits, accorded freedom to determine interest rates on fcnr deposits within ceilings and allowed to use derivative products for asset - liability management purposes. similarly, corporates were given flexibility to book forward cover based on past turnover and allowed to use a variety of instruments like interest rates and currency swaps, caps / collars and forward rate agreements in the international forex market. rupee - foreign currency swap market for hedging longer term exposure has developed substantially in the last few years. market profile the indian forex market is predominantly a transaction based market with the existence of underlying forex exposure generally being an essential requirement for market users. similarly, regulations in most cases require end users to repatriate and surrender foreign exchange in the indian forex market. all forex transactions of government of india are routed through the market except for aid transactions. the forex market is made up of authorised dealers ( generally banks ), some intermediaries with limited authorisation and end users viz., individuals, corporates, institutional investors and others. market making banks ( generally foreign