YV Reddy, governor, Reserve Bank of India (RBI), said that presently, managing the challenges of the impossible trinity – fixed or managed exchange rates, open capital accounts and discretion in monetary policy in the emerging market economies (EMEs) – can be done in a manner that could be termed as ‘fuzzy’ rather than satisfactorily resolved.

“It is a problem that gets exacerbated due to huge uncertainties in global financial markets and possible consequences in the real sector”, said Reddy at the Swedish central bank, Sveriges Riksbank, Stockholm on Friday. Reddy said that further deepening of financial markets may help in absorption of large capital inflows in the medium term, but it may not give immediate succour at the current stage of financial sector development in many EMEs, particularly when speed and magnitude of flows are very high. Going forward, the consequences of global uncertainties in financial markets could be more serious for EMEs compared to the other nations.

The choice of the instruments for sterilisation and other policy responses have been constrained by a number of factors – the openness of the economy, depth of the domestic bond market, health of the financial sector as well as the public finances, country?s inflationary track record and the perception about the credibility and consistency in macroeconomic policies pursued by the country.

EMEs should carefully monitor the scenarios in currency markets, liquidity conditions, globally dominant financial intermediaries, impact on real sector through credit channel and asset prices, etc and be ready with appropriate policy strategies and contingency plans.

He enumerated some issues in the conduct of monetary policy in India. They are: managing the transition of Indian economy to high growth trajectory accompanied by a low and stable inflation and well-anchored inflation expectations, longer-term structural bottlenecks in supply with less than adequate assurance of timely, convincing and demonstrated resolution of these issues, some categories of interest rates are yet to be fully liberalised in the system, thereby muting at least partly, the impact of monetary policy actions on the structure of interest rates.

Reddy also said that monetary policy had to contend with large fiscal deficits and high levels of public debt by international standards.