demand would create excess supply in the economy, putting downward pressure on inflation. to bring inflation back to 2 per cent over a period of 18 to 24 months, the bank of canada would lower its target for the overnight interest rate. through its effect on market interest rates and the exchange rate, this action would increase the level of output in the economy, moving it back towards production potential. inflation would, therefore, return to the target shortly after the excess supply disappeared from the economy. an upward shift in demand would, of course, generate symmetric responses. while the theory is clear about the appropriate response to demand shocks, the magnitude and persistence of shocks — and hence the size and timing of interest rate adjustments — are always difficult to judge. this is where the art of monetary policy - making comes into play. it is even more difficult, of course, to gauge the appropriate monetary policy response to supply shocks — which take the form of higher ( or lower ) inflation than expected for a given level of demand. the interaction of fiscal and monetary policies is covered more fully in dodge the bank ’ s framework for inflation targeting allows temporary supply shocks to be largely ignored, as long as they do not feed into inflation expectations. the credibility that has been established means that they typically no longer do so. consider price surprises coming from the most volatile components of the consumer price index — components such as fruits and vegetables or fuel oil and natural gas. as our operating guide, we use a measure of core inflation that excludes these components. this gives us, and economic observers, some confidence that we are looking at something close to the underlying trend of inflation. thus, our interest rate response to price shocks that are perceived to be temporary can be minimal. as a result, there will be little effect on output. in other words, monetary policy does not turn temporary supply shocks into something that is destabilizing for aggregate output. a more difficult situation occurs when persistent increases or decreases in prices coming from the most volatile components of the consumer price index threaten to keep the total index away from the target for a significant period of time. credibility helps here too, but the bank must be particularly cautious that these movements in inflation do not feed into inflation expectations. supply shocks that take the form of a change in the level, or growth rate, of potential output are often hard to recognize. here, however, the key is for the central bank to return the trend of inflation to the target if it has moved away. since the

11. yet we have quite some distance to traverse to catch up with our neighbours in the far east, let alone the advanced western countries. the 7i framework in this backdrop, i intend to discuss the development of the debt and the derivatives market in india from the perspective of a central bank and a financial sector regulator with a mandate to facilitate development of debt markets of the country. i shall briefly cover some of the important initiatives taken so far and also draw the contours of future development. my discussion will be structured within what i call the 7i framework – the seven i ’ s standing for investors, issuers, instruments, infrastructure, intermediaries, incentives and innovation – each an important and critical component of any well - functioning and vibrant financial market. investors any discussion of development of a bond market has to begin with the investor. high savings rate, large set of domestic institutional investors and active interest from foreign investors can create a large and heterogeneous group that is necessary for an efficient bond market. the traditional investor base for g - sec in india comprised banks, provident funds, and insurance companies. with the entry of co - operative banks, regional rural banks, pension funds, mutual funds and non - banking finance companies, the institutional investor base has been reasonably diversified. notwithstanding the predominantly institutional character of the g - sec market, reserve bank of india has recognised merit in promoting retail participation and has initiated certain policy measures to this end. some of these include enabling small and medium sized investors to participate in the primary auction of g - sec through a “ scheme of non - competitive bidding ”, improving access to the market for mid - segment investors by permitting well - managed and financially sound urban cooperative banks ( ucbs ) to become members of nds - om and revision of authorization guidelines for the primary dealers ( pds ) mandating achievement of minimum retailing targets. to ease the process of investment by retail / mid - segment investors, a web - enabled platform which would seamlessly integrate their funds and securities accounts has been planned by the reserve bank of india. some major banks have also initiated measures like on - line trading portal for the retail investors. an important feature of investor profile of the g - sec market is the dominance of domestic investors and limited foreign participation but this is an aspect of a policy framework rather than indicative of lack of interest by overseas investors. investment limits for the foreign institutional investors ( fiis ) have been enhanced in a phased manner to us $ 15 billion