"The fundamental issue in the conduct of the monetary policy... relates to striking of a balance between the quantum of liquidity required to support economic activities and the interest rates which are reckoned in investment decisions," states the RBI annual report.

lt will become imperative to establish MCI in not too distant a future, it adds.

However, information requirements for evolving a Monetary Conditions Index are substantial. In the Indian context, the absence of high-frequency data on output developments and turnovers in different markets, in particular, circumscribe the perspective of monetary condition, the report states.

The index is likely to overshadow instruments such as the cash reserve ratio. But at least in the shortterm, the central bank will perforce have to fall back on traditional instruments like the bank rate, cash reserve ratio and refinancing in support of open-market operations (OMO). To ensure that OMO becomes effective, it is necessary to expeditiously bring about institutional changes that broaden and deepen the financial markets, the report states.

On the relevance of the MCI, the apex bank has said that following the financial innovations and sharp reductions in transaction costs, variations in quantity aggregates could no longer explain appropriately the variations in aggregate demand and prices.

This has prompted the developed economies to switch from targeting quantity aggregates to rate variables such as short-term interest rates or the exchange rate, or sometimes even directly targeting the goal variable, inflation.

MCI typically reflects the degree to which monetary policy measures have been resisting inflationary pressures in the economy. It is measured as the weighted sum of the change in theshort-term interest rate and exchange rate relative of the base period.

Apart from the interest rate and the exchange rate, it is feasible to use any other variable which has a bearing on the goal variable of the monetary policy and which the central bank could influence.

For example, technically bank credit could be used in the absence of the central bank's control over the financing of the government deficit as well as over the behaviour of the net foreign exchange assets of the banking sector, under a monetary targeting framework.