( 2010 / 11 ), as a percentage of gdp, is lower, the absolute amount of government borrowing in gross terms is roughly of the same order as in last year. indeed, measured by the metric of fresh supply of government paper, the borrowing this year will be higher than in last year, and this perhaps will be a more influential determinant of the yield trajectory. meanwhile, the economic conditions have changed since last year in important ways. first, inflationary pressures are stronger, thereby restraining the flexibility for infusing liquidity through open market operations ( omo ). second, last year banks held significant quantities of market stabilization scheme ( mss ) bonds issued earlier for sterilizing the liquidity arising from capital flows. the reserve bank bought back those bonds to infuse systemic liquidity. that option is not available this year as the quantum of mss bonds remaining is very marginal. finally and importantly, as recovery is taking hold, private credit demand is reviving. but the upward pressure on yields on government securities and the consequent pressure on interest rates makes “ crowding out ” a potential possibility. 26. even setting aside crisis related developments, “ fiscal dominance ” of monetary policy continues to be a concern. the long term interest rates are influenced significantly by the yields on government securities and hence on the size of the government borrowing programme, thereby eroding to some extent the efficacy of monetary transmission. the credibility of the reserve bank ’ s inflation management, therefore, is critically dependent on the credibility of government ’ s fiscal consolidation. 27. fiscal consolidation is important for a number of other weighty reasons apart from the inflation dimension. the government has initiated action on the recommendations of the thirteenth finance commission ( tfc ) on the revised road map for fiscal responsibility. in drilling down the road map, the government should also keep in view two relevant objectives. first, fiscal consolidation should shift from exclusive reliance on increasing revenues to focus on restructuring expenditures. the consolidation effort should target slashing recurring expenditures rather than one - off items. second, it is important, even as targeting quantitative indicators, to pay equal attention to the quality of fiscal adjustment. improving monetary policy transmission 28. the standard tool of central banks is the short term interest rate which they use to influence interest rates across financial markets, and thereby steer the financial conditions in the economy. during the crisis, central banks around the world reduced policy rates ferociously, and in many advanced economies the rates are at or near zero

comprise borrowed funds which are qualitatively different from accumulation of reserves through trade and current account surpluses. even so, it is clear that the reserves have helped us better cope with external sector vulnerabilities. 17. our fairly flexible exchange rate policy has not been without costs. importantly, because inflation in india has typically been higher than that in our trading partners in the recent period, the real effective exchange rate has appreciated significantly more than the nominal rate. this has implications for our external competitiveness, that too at a time when the world trade is recovering amid concerns relating to protectionism. also if we have a flexible exchange rate, and if other countries which are our trading partners or those which compete for the same export markets have a fixed exchange rate, we get disadvantaged. inflation targeting 18. the reserve bank is not a pure inflation targeter. some people have suggested that the economy will be better served if the reserve bank becomes a pure inflation targeter. the argument is that inflation hurts much more in a country like india with hundreds of millions of poor people and that the reserve bank will be more effective at combating inflation if it is not burdened with other objectives. this argument is contestable. 19. inflation targeting, characterized by a single target ( price stability ) and a single instrument ( short term policy interest rate ), has respectable academic credentials. an exclusive commitment to inflation enhances operational effectiveness and enforces accountability. the success of several developed economy central banks in maintaining price stability in the years before the crisis has also given it intellectual credibility. the unravelling of the “ great moderation ” during the crisis has however diluted, if not dissolved, the consensus around the minimalist formula of inflation targeting. the crisis has shown that price stability does not necessarily ensure financial stability. indeed there is an even stronger assertion – that there is a trade - off between price stability and financial stability, and that the more successful a central bank is with price stability, the more likely it is to jeopardize financial stability. 20. inflation targeting is neither desirable nor practical in india for a variety of reasons : • first, it is inconceivable that in an emerging economy like india, the central bank can drive a single goal oblivious of the larger development context. the reserve bank must be guided simultaneously by the objectives of price stability, financial stability and growth. • second, food items which have a large weight ( 46 – 70 per cent ) in the various consumer prices