While speaking on `Monetary Policy in India: objectives, instruments, operating procedures and dilemmas' at the `Securities Industry summit' organised in Mumbai on Wednesday, he added that the monetary policy strongly influences the working of financial markets in the country.

"However, monetary management poses dilemmas not only at the analytical level but also at the operational level," the deputy governor said, adding that the RBI is constrained by the conflict between its roles as a regulator /supervisor and as a conductor of the monetary policy.

"The monetary authority may require it to reduce liquidity in the system by raising the ratesof interest, but such rise could be detrimental to the weak banks. Similarly, while tightening prudential norms, the central bank has to take into account its impact on the banks' capacity to intermediate credit," Reddy said.

A basic dilemma faced by the RBI in monetary management arises out of the trade-off between growth and inflation. "Given the deleterious effects of inflation on distribution of income, there is an imperative need to keep the inflation rate as low as possible and this impacts the growth," he said.

However, he added that even a moderate inflation rate poses a dilemma in the open economy if its is higher that the average inflation rate of its trading partner, because it puts pressure on the exchange rate.

"In an open economy, the conflict between the interest and exchange rate objectives could arise when short-term and volatile capital flows occur. Another dilemma arising out of the continually evolving financial markets and payments systems is that there is no clear cut evidence ofstability in the monetary demand, which is taken as a basis for immediate targetting. To minimise its effect, RBI has to track a number of relevant variables," Reddy said.

He added that the reforms in the monetary and financial sectors have enabled the RBI to expand the array of instruments at its command. "Howver the use of cash-reserve-ratio (CRR) as an instrument of monetary control is sought to be de-emphasised and the liquidity management in the system is increasingly undertaken through open market operations, both outright and repos," the RBI deputy governor added.