to match capital flows if they happen to be volatile. furthermore, the level of current account deficit in respect of emerging market economies that is generally considered as sustainable by the global financial markets may be lower than the sheer volume of capital inflows in these economies. it is sometimes suggested that encouraging outflows would be a good solution to manage surging inflows. while there is some merit in this approach, liberalising outflows may not be of great help in the short run because a more liberalised regime generally attracts higher inflows. hence, such a policy has to be combined with other measures which could help to effectively manage the flows. in implementing a calibrated process of liberalisation of capital account, co - terminus with developments in other sectors, there are several issues that are addressed in regard to managing capital flows in the short run. these are : ( a ) whether the capital flows are judged to be large and lumpy ; ( b ) whether they are assessed to be temporary ; ( c ) the limits to effectiveness of interventions if the exchange rate movements are unidirectional ; ( d ) the desirable extent of sterilisation, considering costs and the available instruments ; and ( e ) above all, the likely impact of the relevant policy stance and procedural measures on the exchange rate expectations. needless to say, monetary and exchange rate and reserve management are rendered complex in the context of the well known “ trilemma ”, especially in the current global environment. monetary policy monetary policy recognises the growing importance of global factors but the domestic developments play a dominant role. no doubt, the structural transformation underway and the continued significance of public sector in financial sector as well as notable prevalence of administered interest rates make the tasks particularly complex. while there has always been a dual mandate of the rbi, it has, in recent years, successfully articulated a selfimposed tolerance limit of five per cent on headline inflation. the tightening of monetary policy commenced in october 2004 and there have been seven increases of 0. 25 per cent in the repo rates till march 2007, to address early signs of possible overheating during the period. to meet the challenges of excess liquidity on account of surge in capital flows, the cash reserve ratio in regard to banking system has been increased in ten instalments since september 2004 till date, aggregating three hundred basis points. currently, there are acute policy dilemmas arising from global food and energy prices as also from financial market turbulence

. in addition, prudential limits have also been placed on the extent to which banks may access the inter - bank call money market both as a lender and as a borrower. ninth, whenever out - of - the - ordinary situations arise, exceptional or flexible arrangements are needed. timely flexibility, while reacting to the underlying balance is essential. this helps in avoiding more serious problems relating to the balance over the medium - to - longer term. for example, recently oil imports had to be financed through off - market processes. delayed adjustments to such sudden and unexpected cross - border exogenous developments at such times may impose a stress on liquidity. hence, addressing frictional issues of liquidity as distinct from underlying issues of levels of liquidity is required to look at the balance dynamics. thank you.