##ties about the sustainability of the recovery have arisen. if this continues, it will help to reverse the trend in this component of the index. but, the most significant cause of reversal is likely to be a moderation in food prices over the next few months in response to a reasonably good monsoon. the other supply - side driver of inflation in recent months has been energy. the inflation rate for the fuel component of the wpi began rising in june 2009. though it remained in negative territory until october 2009, the rise itself contributed to a rise in the overall inflation rate. from october 2009 onwards, fuel inflation has been positive and rising quite rapidly. in short, the indian economy has clearly seen a spurt of inflation, significantly driven by supply - side factors in a period during which growth was relatively slow. prevailing wisdom on monetary policy suggests that supply - side pressures, particularly if they are temporary in nature, are not effectively tackled by conventional monetary measures, which are more directly aimed at reining in demand. apart from the temporariness of these supply - side factors, the overall state of the economy should also be considered. the same wisdom argues that, if the economy is at or close to full capacity utilization, monetary actions in response to supply - driven inflationary pressures may be appropriate. while they will not directly address the cause of the inflation, by signaling a willingness to compress demand, they will rein in expectations of inflation spiraling out of control. the fact that the economy was still growing at a relatively slow pace in the second half of 2009 – 10 implied that there was some slack still available in capacities across sectors and that the threshold for strong monetary actions had not yet been reached. however, monetary assessments at that time could not be made independently of the very drastic measures that had been taken when the global crisis precipitated in september 2008. those actions took the monetary position, as reflected in the repo and reverse repo rates and the cash reserve ratio ( crr ) quite some distance from what would be considered normal levels. even in the early stages of recovery, therefore, every opportunity to revert these instruments to normal needed to be exploited. i shall return to this point a little later in the article. the rising significance of demand coming back to the inflationary situation, while a significant proportion of the rise in the inflation rate over the past year can be attributed to supply - side factors, demand pressures became visible in early 2010. while it is difficult to identify a

of the monetary actions listed in the table. first, even while the indian economy has recovered quite rapidly from the slowdown, there is persistent global uncertainty. emes have generally done quite well in coming out of the crisis, but a major part of the global economy – the us, the uk, the euro zone – is not only showing only very modest signs of recovery, it is also manifesting new stresses, partly as a result of the huge build - up of sovereign debt, which governments used to support their various fiscal stimulus packages. over the past few weeks, optimism about a sustained, even is slow, global recovery, has been giving ground to concerns about another imminent slowdown. one thing that we learnt from the events of 2008 – 09 was that india is not immune to global turbulence. be it through trade, capital flows or a general sense of confidence about economic prospects, a global problem quickly becomes a domestic one. given these linkages, the risks from the global economy need to be taken into consideration while formulating domestic policy. second, the reality is that the policy instruments are far from being in a normal position. as the economy recovers, it is imperative that policy instruments be brought as quickly as possible back to a position consistent with the state of the economy. this is essential for the management of expectations as well as to re - create the capacity to respond, should another shock hit the economy. but, as important as it is to return to normal quickly, it is equally necessary to do so non - disruptively. the kind of rapid and massive reductions that were made to instruments during the crisis simply cannot be replicated in the reverse direction. growth is picking up and confidence gradually returning to businesses and consumers, but given the vividness of the crisis, the process is still likely to be vulnerable to both external shocks and domestic ones. rapid transitions in the policy regime might constitute one such shock. in essence, on this consideration, while rapid and drastic actions are entirely warranted when dealing with a crisis, managing a return to normalcy requires a more gradualist and calibrated approach. third, notwithstanding the above two issues, the fact is that inflation has taken hold, with both supply and demand pressures contributing to it. monetary policy must respond. the table indicates that it indeed has. action on rates and liquidity, through the crr, began in january and has continued at the measured pace indicated earlier over the past six months. one strong criticism of the reserve bank