debt flows and for long term flows over short term flows. but in the real world, we seldom find ourselves in such a sweet spot ; capital flows are either too much or too little. when capital flows are far in excess of cad, the exchange rate appreciates out of line with fundamentals. and if the flows are volatile, that will be reflected in the exchange rate movement too. the reserve bank then has to make a judgment on whether or not to intervene in the forex market. this is not as straight - forward as it seems. if we intervene to buy foreign exchange in the market, volatility may be smoothed and exchange rate bis central bankers ’ speeches appreciation contained, but systemic rupee liquidity goes up, and that could add to inflationary pressures. inflation, as we know, results in a real appreciation of the currency. so, our effort to solve the problem of nominal appreciation of the currency, lands us with a problem of real appreciation. to get around this problem, that is to contain inflationary pressures, we sometimes “ sterilize ” the excess liquidity. this may contain inflation pressures, but raises a host of other problems. sterilization puts upward pressure on interest rates which erodes our competitiveness. higher interest rates also attract more capital flows, thus again, in a curious variant of the dutch disease, accentuating the very problem that we were, in the first place, trying to resolve. as you see, there are no straight - forward solutions – every solution raises a fresh problem. volatile capital outflows pose similarly complex policy choices. in this case, the exchange rate tends to depreciate, again out of line with fundamentals exacerbating inflationary pressures and also hurting the government and corporates who have external debt obligations. in an outflow situation, financing of the current account deficit could also turn into a problem. both when inflows and outflows are out of line with our requirement, the reserve bank has to make a determination on whether or not to intervene in the foreign exchange market to contain volatility and prevent instability. as i explained above, no option is totally benign ; no matter what option we follow, there are costs. our effort always is to make an assessment of the forces driving the capital flows and act only to smooth volatility in the exchange rate movement and prevent disruptions to macroeconomic stability. in doing so, we have to be mindful of the inflation situation,

the most basic and fundamental level, most un - euphemistically speaking, it all boils down to summoning courage to remove – this phrase was very common in similar policy debates in the 980s – the “ punch bowl ” when the party is on! for the problem is not knowing the problem, but knowing it and dithering, agonizing over choices, temporizing, procrastinating and doing nothing credible, timely, tangible and decisive about it. in other words, paraphrasing john ruskin, what finally matters is not knowing what must be done but actually doing what must be done and doing it when it must be done!! thank you all so very much. - x - x - x - x - x - x - x - bis central bankers ’ speeches table asset / index avg. of daily gold to asset price ratio ( mar ’ 2000 – feb ’ 2010 ) current ratio as on jan 27, 2012 levels as on jan 27, 2012 implied price of gold as on jan 27, overvaluation as on jan 27, 3. 57 13. 34 130. 39 ( 1 ) x = 465. 49 6. 24 22. 04 78. 90 cdx ig * 5. 50 18. 21 dow jones 0. 05 jp morgan us treasury 7 – 10 yr bond index lmex wti caseshiller us national home price index dxy overvaluation as on sep 14, overvaluation as on oct 27, 274 % 292 % 169 % 492. 34 253 % 280 % 174 % 95. 48 525. 14 231 % 251 % 149 % 0. 14 12660. 46 633. 02 175 % 224 % 138 % 1. 27 2. 66 654. 73 831. 51 109 % 123 % 78 % 0. 26 0. 46 975. 78 78 % 84 % 34 % 10. 76 17. 47 99. 56 1071. 3 62 % 90 % 50 % ( closing spot gold price as on jan 27, 2012 was at us $ 1739. 07 ) ( source - bloomberg ) * the earliest cdx ig data are available from september 24, 2004. the average value of series 3 has been used as a proxy for cds from march 1, 2000. the cdx spread - based index values have been converted into price - based values so that the ratio of gold price and implied cds price can be worked out on a “ comparing apple