The central bank is facing a dual challenge of preventing the rupee from appreciating and absorbing excess liquidity at the same time.
The RBI seems is in no urgency to move towards full capital account convertibility. Reddy, in a speech, stated, "In view of the proven success of our overall approach to reform over the last 15 years, there is considerable merit in pursuing the gradualist, participative and harmonious approach towards further reforms in financial and external sectors."
There are reasonable grounds for optimism with regard to prospects for the Indian economy, and this has been globally recognised.
However, it is necessary to remain guarded in matters relating to economic growth and stability of an emerging market economy in the current global environment of high output growth, notable inflation pressures, persisting global imbalances, incipient signs of re-pricing of risks, and perceived volatility of capital flows, Reddy emphasised.
In terms of immediate prospects, the RBI expects the GDP in FY08 to be around 8.5 per cent, assuming that there is no further escalation in international crude prices or domestic/external shocks. In FY08, the governor added that the central bank's policy endeavour would be to contain inflation close to 5 per cent.
In the medium term however, recognising India's evolving integration with the global economy and societal preferences, the resolve is to condition policy and expectations for inflation in the range of 4-4.5 per cent.
Reddy added that the tolerance level to inflation has been low in developing countries, especially on account of democratic pressures in the country.
He also indicated that there have been some signs of deceleration in the growth of credit recently. Taking into account the high expansion of money supply worldwide and given the monetary overhang of 2005-07, Reddy emphasised the need to contain monetary expansion in FY08 at 17-17.5 per cent from the current 21 per cent in consonance with the outlook on growth and inflation.
Reddy said, in assessing short-term prospects say for 2007-08, it is essential to recognise that the impressive growth in GDP at 9.4 per cent reflects the contribution of both the structural and cyclical factors, though their relative contribution is somewhat non-quantifiable.
The critical task before the public policy and the RBI, in particular, is to strengthen the structural factors in the economy but determinedly moderate the cyclical and excessively volatile elements of the economy.
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