As inflation rates have hardened beyond tolerable levels, monetary policy would continue to address the current aggregate demand pressures, said the Reserve Bank of India (RBI) in its annual report of released on Friday.
An overriding priority for the monetary policy would be to eschew further intensification of inflationary pressures, it added.
However, at the same time, there is need to improve the supply position in some critical sectors. In order to tackle food price inflation, the demand-supply mismatches need to be addressed over the medium term, which would necessitate raising crop yields through the use of modern technology, improved irrigation facilities as well as provision of market-based incentive systems for the farmers both in the credit and product markets.
The conduct of monetary policy has become more challenging recently for a variety of factors. First, it is necessary to recognise global dimensions of the crisis, which is threatening the credibility of monetary policy worldwide.
Second, localised factors such as banks? balance sheet adjustments in the run-up to the year-end closure of accounts and advance tax flows have also influenced liquidity conditions.
Third, the evolving fiscal situation in an atmosphere of persistent inflationary pressures poses severe challenges to monetary management, especially if supply inelasticities continue to prevail in the short-term. Thus, there is a need to ensure that effectiveness of monetary policy is not undermined by fiscal expansion. Fourth, it is necessary to recognise that monetary policy has also to reckon with the structural components embedded in the drivers of inflation which, unlike cyclical elements, are somewhat impervious in the short run to instruments of aggregate demand management.
Fifth, it needs to be recognised that existence of stipulated SLR prescription of 25% of net domestic demand and time liabilities of banks hampers the genuine development of the government securities market.
